Thermostats Not Thermometers

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

Marketing and change guru Seth Godin has this crazy idea that the world needs more thermostats rather than more thermometers.  I agree.  Is your risk management team a thermostat or a thermometer?  I trust that question makes sense to you.  Does it make sense to your risk department?  It didn’t make sense to buggy-whip manufacturers at the turn of the century.

RSD Solutions – financial risk consulting and training
http://www.rsdsolutions.com

The Perfect Calm

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

November 19, 2010

The past three years have been the perfect storm for financial institutions in terms of their risk management.  Chaos (folly) seemed to be the operating mode during the height of the financial crisis.

What about corporate financial risk though?  It seems to have been lost in the shuffle of the daily business news and perhaps understandably so.  Relatively speaking, exchange rates have been calm – although the recent saber rattling about currency wars might be shifting.  Interest rates for most of the world were at record lows before the crisis and, since, central banks have been playing a game of limbo dancing to see how low they can drive their domestic rates.  It seems that only commodity prices and perhaps demand have been relatively volatile.

Has the recent past then been a case of the perfect calm for corporate financial risk?  Will the lessons learned from the financial institutional mess translate to the corporate world?  (Were there lessons learned from the experiences of the financial institutions?)  One thing for sure is that the road to recovery (hopefully there will be a road to recovery) is likely to be interesting risk wise.

RSD Solutions – financial risk consulting and training
http://www.rsdsolutions.com

Fuzzy Or Garbled

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

Just finished reading an older (1997) book called “The Universe and the Teacup” by K.C. Cole.  She made an interesting point in this very readable and entertaining mathematics book about how “fuzzy logic is associated with garbled thinking”.  Fuzzy logic of course is a branch of mathematics that does not subscribe to the normal black and white thinking that we have commonly come to associate with mathematics.  Fuzzy logic, which has many wide-spread practical applications, basically asserts that while some answers and measurements are more correct than others, there is not an absolute value or answer to some questions and equations.

The interesting thing about this is that when you think about it, most of your daily actions are based on fuzzy thinking.  How did you decide what to have for breakfast this morning?  How did you decide what e-mail you would open up first?  When asked by a colleague how your day was going, how did you decide to respond?

Fuzzy logic is not garbled thinking.  Fuzzy logic is reality.  Perhaps it is our insistence in risk management on strict black and white absolute value thinking that is garbled.

RSD Solutions – financial risk consulting and training
http://www.rsdsolutions.com

Billy Collins

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

Mathematician Keith Devlin is quoted in “The Universe and the Teacup” by K.C. Cole as saying, “To really understand what it means to think rationally, mathematics will need to team up with psychology and sociology, and perhaps even biology and poetry.”

This was very similar to a presentation I made earlier this summer to the CFA Society of Toronto on New Axioms, Assumptions and Paradigms of Risk Management http://www.rsdsolutions.com/quotrisk-management%0Bnew-axioms-assumptions-and-paradigms, (see in particular slide 37), and a different presentation I made on “Sociological Finance” to the 2010 CFA Pension Conference in Toronto.

Risk management, as well as mathematics, needs to learn from sociology and psychology.  To be clear I am NOT talking just about behavioural finance.  Sociology, psychology, and biology tell us about complex systems and how complex systems and human interactions evolve (become emergent to use the technical term).  What is needed is creative people who are not hung up with the mathematics of risk management.  The confines of mathematics have taken us a long way in risk management, but it is time to realize that we are asking too much of the mathematics and the mathematicians.  Perhaps it is even time for risk departments to employ poets.  I wonder if Billy Collins is interested in doing some moonlighting.

RSD Solutions – financial risk consulting and training
http://www.rsdsolutions.com

Surfing or Passion?

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

Last week I read Yvon Chouinard’s book “Let My People Go Surfing”.  Yvon is the founder of Patagonia clothing company and I think I may be the last business person on the planet to have read his book.   In case you have not read it, it is the story of his founding of the company and the many path-breaking business principles that he and his associates founded, such as on-site day-care and flex time, etc. etc.  The book also outlines how he, his company and his associates became passionate and active supporters of environmental causes.

The book is a fascinating case study in how to run a company.  So many of the business practices that Yvon and his partner’s started are now common-place benchmarks – but they were anything but when he first introduced them.

When the company first started making mountain climbing gear, they warned their customers not to expect fast service during mountain climbing season as they (the founders) would be out mountain climbing rather than filling customer orders.  This passion for activity and passion in their chosen field, rather than following best business practices turned out quite well for them.  The title of the book of course refers to the fact that employees are encouraged to go surfing when the conditions are good, rather than wait until the 5 o’clock whistle has blown.

Yvon is obviously a very smart but also a very charismatic person.  (I assume he is charismatic from the way that the book was written.)  His company is a blue-print for many others that have tried to follow in his footpaths.  His book is also a popular read amongst B-school types. 

This brings up an interesting question.  Is Patagonia and Yvon successful because of his passion for mountain climbing and surfing, or is he successful because of his passion, or is he successful because of his education (he basically has no formal post-secondary education)?  Can risk managers be successful in the same way?

RSD Solutions – financial risk consulting and training
http://www.rsdsolutions.com

Simulation Exercise

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

This past weekend, the MBA students at the school where I am an Associate Professor (Dalhousie University) completed a weekend long computer simulation exercise.  The well-known computer simulation – that many MBA programs utilize – is quite complex as it incorporates a wide variety of interconnected factors as it tries to give students a feel for what it is like to make decisions in a real-world competitive environment.

The students appeared to enjoy participating in the simulation quite a bit and I took the time out to sit in on the debrief which was being conducted by one of the schools more engaging professors.  The professor had the students going discussing the thinking that led to their success or failure in the complex simulation. 

After a short period of time, the discussion amongst the students was quite lively.  However, it took a turn that perhaps was unexpected by the professor.  Despite his best efforts to steer the conversation towards business principles, the students kept steering the conversation towards their efforts to reverse engineer the game.  In other words the students who were best at the game were not necessarily winning because they were using the best business practices.  Instead they were winning because they were best at figuring out the artificial constraints and limitations of the computer simulation.

Here is the issue for risk management:  do we become good risk managers because we make good risk based decisions or because we make decisions that are based on how the artificial constraints and limitations of the risk management game (and regulatory game) are imposed?

RSD Solutions – financial risk consulting and training
http://www.rsdsolutions.com

Getting Older

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

I am just about finished rereading a book that I bought several years ago.  When I first bought the book and read it, I did not really like it.  It was ok, but no real insight was gained, and it did not stimulate any cool thoughts. 

For some reason that I really cannot state I started re-reading the book last week again.  Why I would re-read a book that I did not particularly like the first time through is an interesting question.  I guess I was bored and too lazy to seek something else better to read at that particular time.

The funny thing is though that I am really enjoying the book this time through.  I am getting a lot of great ideas from it, and find it quite stimulating.  Why?  I have no idea other than the fact that I am now about 10 years older.  Does that mean that I am also 10 years wiser and thus more able to appreciate things that I glossed over before?  Or does it mean that I have forgotten so much that virtually everything is new and exciting for me as if I am seeing it for the very first time?

RSD Solutions – financial risk consulting and training
http://www.rsdsolutions.com

Risk Smile

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

I bet when you clicked on this link you thought there would be something about volatility smiles.  Probably not for a couple of weeks though (that is when I discuss that topic with my MBA Derivatives class).  Nope, this blog is about smiling.  That is the thing that you do when you are happy and cheerful.

In this blog I would like to ask you if your risk department, or your risk consultants make you smile.  Do they?  If you are a risk manager, or a risk consultant, do you make other people in the organization smile?  That is, while you are doing your job.

I think that risk managers should be making people smile.  Risk management is about getting things done in a prudent manner.  Risk management is about creating peace of mind.  Risk management is about creating opportunities.  Risk management is about increasing the probability and magnitude of good risk events happening (while decreasing the probability and severity of bad risk events happening).  All of these are good things.  Good things make people smile.  (….with apologies to Martha Stewart).

RSD Solutions – financial risk consulting and training
http://www.rsdsolutions.com

Fighter Jets and Chaos

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

I was doing a bit of studying lately on Chaos, which is a field of science that has interested me since I was in high school.  As a field of study it is really quite neat, but not as practical as complexity.  The issue is that it is harder to get academic papers published in complexity and thus the scientific establishment pushes forward with chaos.

One of the things I learned earlier this week in my readings was that fighter jets are designed to be chaotic.  That is they are specifically designed to be unstable.  While this might be an undesirable trait in a commercial airliner, it is very attractive for fighter planes.  The instability – chaos – allows the plane to be much more maneuverable in crisis situations.  The instability actually serves a useful and valuable purpose.

This led me to consider the use of risk systems by most firms.  The goal in risk management – to my chagrin – has been to create ever more inflexible risk systems and frameworks.  The thinking goes that building a rock solid stable risk framework leads to a rock solid firm.  However I think a lesson can be taken from the design of fighter jets.  Perhaps a rock solid risk system is putting too much rigidity into the firm’s culture and thus when a crisis does occur the firm does not have the degrees of freedom necessary to take effective action.  The inertia of the firm’s risk system does not protect, but actually makes the firm more vulnerable. 

Perhaps it is time to add more chaos to get less chaos.  After all, isn’t business just like war?

RSD Solutions – financial risk consulting and training
http://www.rsdsolutions.com