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Thursday, April 16, 2009

Mindsets and Models and Risk

From Knowledge@Wharton: Re-thinking Risk Management: Why the Mindset Matters More Than the Model. Good piece on how to think about new architectures of risk. In the past large companies cranked out the financial models and if they were even off by a small amount the system was adjusted. Now changes in the models have to be considered:

" ... The models are not necessarily broken, but instead are only as good as the decisions that get made based on them, they say. As a result, the current crisis may represent an opportunity for companies to re-visit and re-think historical approaches to risk management. When it comes to planning for the future, the new thinking goes, it is not just the model that matters, it is the mindset ...
Well, if the models did not include a 'mindset' (whatever that is exactly) I would say that they are broken. It is the classic problem of not including external factors in a model. Those external factors were stable for a long time ... but no longer. In other words, throwing money at it may not work.

Update: Ken Karakotsios does some additional exploration of this in considerable data. Check out his prototype models.

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