Thursday, April 10, 2008

NPR on Risk

Since Alan Greenspan basically blamed the subprime crisis on bad risk models, some mainstream news organizations have felt obliged to look at this abstruse topic. Unfortunately, risk is hard to understand, and therefore hard to explain. Especially in three minutes.

NPR aired a piece on risk yesterday which started off by talking with a guy who writes risk management software, then gets to this:
Aziz says that to understand why the software failed, you have to understand the basic mathematics of risk management. And to do that, you have to go somewhere unexpected: a botanical garden.
Then comes a description of Brownian motion, complete with the pollen particle suspended in water. And that's it for describing how risk is measured. But why do these models fail?
Brownian motion works best with truly random things, like little bits of pollen that bounce around with no rhyme or reason. But financial markets are not random. They are linked. Risk management software is not always good at figuring out how those global links work.
I can't imagine that a single listener was remotely enlightened by this report. Admittedly, NPR set itself up for an impossible task. There is no way NPR could have given even the simplest explanation of risk in the time allotted. But NPR made it even more difficult by taking a detour to the botanical gardens.

One gets the feeling that the network felt it had to say something about risk, but in this case, saying nothing would have been the better choice.

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