Leave Something on the Table
What was the difference between the banks and insurers with high tech risk management programs that did extremely poorly in the GFC from those with equally high tech risk management programs who did less poorly?
One major difference was the degree to which they believed in their models. Some firms used their models to tell them exactly where the edge of the cliff was so that they could race at top speed right at the edge of the cliff. What they did not realie was that they did not know, nor could they know the degree to which the edge of that cliff was sturdy enough to take their weight. Their intense reliance on their models, most often models that focused like a lazer on the most important measure of risk, left other risks in the dark. And those other risks undermined the edge of the cliff.
Others with equally sophisticated models were not quite so willing to believe that it was perfectly safe right at the edge of the cliff. They were aware that there were things that they did not know. Things that they were not able to measure. Risks in the dark. They took the information from their models about the edge of the cliff and they decided to stay a few steps away from that edge.
They left something on the table. They did not seek to maximize their risk adjusted returns. Maximizing risk adjusted return in the ultimate sense involved identifying the opportunity with the highest risk adjusted return and taking advantage of that opportunity to the maximum extent possible, then looking to deploy remaining resources to the second highest risk adjusted return and so on.
The firms who had less losses in the crisis did not seek to maximize their risk adjusted return.
They did not maximize their participation in the opportunity with the highest risk adjusted return. They spread their investments around with a variety of opportunities. Some with the highest risk adjusted return choice and other amounts with lesser but usually acceptable return opportunities.
So when it came to pass that everyone found that their models were totally in error regarding the risk in that previously top opportunity, they were not so concentrated in that possibility.
They left something on the table and therefore had something left at the end of that round of the game.
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