
Expect the unexpected
Comment

The first time I read The Black Swan, I must confess I read it very quickly. I had to introduce Nassim Nicholas Taleb at our OpRisk USA conference and had run out of time. So this summer I've picked up his book again and found in its pages some real surprises.
In the field of operational risk, Taleb's land of 'Mediocristan' is expected loss. 'Extremistan' is unexpected loss, and is the bit of operational risk that most people are really interested in. Unfortunately for op risk execs, Taleb's conclusion is that the Extremistan 'Black Swan' losses are impossible to predict, no matter how much data we have and how fancy our models are. Taleb adds that attempting to predict these losses can be harmful, as the process of forecasting could blind firms to where losses might come from. Particularly when statisticians, economists and analysts are involved.
Now, Taleb's seeming dislike of professional prognosticators is very entertaining - one of my first jobs was tracking equity analyst predictions for a newsletter, and I remember how low the hit rate was. But if we can't predict what will happen in the face of terrifying potential losses, what is the point of operational risk?
Taleb goes on to say that, although "the probabilities of very rare events are not computable; the effect of an event on us is considerably easier to ascertain ... we can have a clear idea of the consequences of an event, even if we do not know how it is likely to occur ... You can build an overall theory of decision-making on this idea. All you have to do is mitigate the consequences."
This seems like such sensible advice to me. This is what business continuity executives do - they focus on having a disaster recovery plan in place that will work no matter what actually happens. What can firms put in place to manage and mitigate large operational risks - no matter what loss event occurs?
I'll stick my head above the parapet even more ... What can firms put in place to prevent large operational risks happening, no matter what type of operational risk event it is?
Basel II's advanced measurement approach is perhaps focused too much on historical loss events and highly latent internal data. For operational risk to move forward, we need to turn this focus on data on its head, and perhaps go for a swim with a Black Swan or two.
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Printing this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Copying this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
More on Risk management
After SVB downfall, EBA stress test seeks out unrealised losses
European regulator asks for data on the fair value and sensitivity of bonds and their hedges
Risk modellers navigate fearful new world of depositor behaviour
Silicon Valley Bank suffered fastest bank run in history, but how should others respond?
Eurex scrambles to avert Treasury collateral ban on US default
Current policy prevents CCP from selectively excluding eligible collateral
Quant Finance Master’s Guide 2023
Risk.net’s guide to the world’s leading quant master’s programmes, with the top 25 schools ranked
UBS found no advantage in quantum computing – ex data chief
Swiss bank tested various use cases in the trading business before giving up on the technology
Op risk data: Frank fiasco costs JP Morgan $175m
Also: Internal fraud burns fewer fingers, but flame is far from out. Data by ORX News
Eurex clearing chief calls for active account carve-outs
Isda AGM: Müller says EU clearing thresholds should exempt market-making and US client trades
CCPs mull collateral options amid debt ceiling deadlock
Isda AGM: Raising haircuts and minimum maturities are among measures on the table to avoid a cliff-edge