Against the Gods: The Remarkable Story of Risk by Peter L. Bernstein
Bernstein places the origin of capitalism in the mathematics of chance. For Ayn Rand, capitalism began with the recognition of individual rights in the Enlightenment. That identification of those rights rested on a largely implicit realization of the individual as such, which began in the Renaissance. We ascribe the idea of the Re... (See the whole review)
Yes, chance as we know it was developed in Renaissance Italy, by Bernouilli, specifically. He was the one who postulated risk versus rewards on a rational cost-benefit basis as a form of betting.
The only problem is that real people don't really behave that way...
This is the story behind Kahneman winning the EconomicsNobel as a research psychologist, which is my chosen field of endeavor. Briefly, most people practice risk aversion when confronted with an odds-favorable bet. OTH, a small percentage of people are natural gamblers who bet compulsively, even when the odds are stacked against them.
That most people do not perform a 'Bernouilli' when confronted with a risk-laden choice is the present-day basis for sinking the economic theory known as 'rational expectations' dead in the water.
Besides this, the notion that pre-Rennaissance people, everywhere, did not indulge in economic risk-taking sounds a bit far-fetched, to say the least. For example, the ancient greecian pipples (my ancestors, maternally speaking) built many, many boats that sailed the two great lakes (Med & Black) in order to trade wine, oil, spice, slaves, exotic woods, you name it.
'Fraid that your guy is telescoping history in order to make some kind of point.
Risk shedding is a form of risk aversion; but it is not a form that unilaterally repeals the role of risk. It is a form that sheds that risk onto others, most often, involuntarily.
Risk in not the same as chance. Chance is not subject to intelligent management without cheating or gaming; no matter how hard you study a roulette wheel in advance, your chance of guessing the next number is pure chance.
Risk, in the context of investing value in pursuit of greater value, is subject to intelligent management, and is also nowhere guranteed. (It -can- be blindly treated like chance, as in, throwing darts at stock picks-- I mean, listening to idiot financial advisors. But that isn't the nature of the intelligent management of risk, that is just Las Vegas.)
It is also subject to criminal gaming, such as, schemes which involuntarily shed risk onto others. Not just the socialization of risk, but the fascist corporatization of risk-- the seeking out of the guns of government for the shed risk opportunities provided at the point of a gun.
Indeed, those boat builders were taking on risk. And no doubt, long after the risk was borne, they were met at the docks by politicians and economists and/or just the tribal mob with theories about the distribution of fish.
"Briefly, most people practice risk aversion when confronted with an odds-favorable bet. OTH, a small percentage of people are natural gamblers who bet compulsively, even when the odds are stacked against them."
I'm involved in a concrete example. A company has wooed a group of investors into risking millions in pursuit of high risk/high reward. They hired a small enclave of fringe research pHds, post docs working at a major research university in a fringe area of advanced mathematics. Their product has been in development for about 10 years, they have not generated dollar one so far. The product underwent live trials overseas with great success this past year. The product was just recently submitted for FDA approval here.
Their risks were and are many. Could the Math Magic be commercialized into a usable product? They didn't know the answer to that when they started out. The FDA might not approve the product. At any point in the process, competitors might come out with something that makes their approach obsolete. Their return on ten years of expensive product development might be zero or less.
Their incentive is the potential high reward. The resulting product is ... remarkable. Magic. Will save lives and grief and discomfort. With FDA approval, will be snapped up by someone like GE in a heartbeat, who, if they want to buy a now risk-free, FDA approved sure thing, will gladly pay a premium for the now guaranteed and developed near miracle producing product...as opposed to watch their competitors buy it and run with it.
Is this 'gambling?' As in, rolling the dice? Hardly. But it is the intelligent management of risk, under a model of high risk, high reward.
Thank God most people aren't all people.
They didn't see the medical devices tax coming when they started out; that's risk, too. But they'll just pass that burden on, and the ladder will be lifted just a bit, denying access to those who won't be able to pay the carcass-carver's toll from afar.
You've acually pointed out a flaw in Kahneman's model that I'm workinng on next semester.
In many cases--business ventures in particular-- risks and rewards remain somewhat unknown. Therefore, since there can be no (Bernouilli-based) rational calculation to begin with, by what standard do you say that any particular individual situation is weighed toward a negative outcome that outweighs potential positive gain?
To this end, one of the more important changes in orientation regarding the recient crash is to no longer see the failures as a result of irresponsible risk. After all, the potential for gain was huge!
Rather, now we see nothing but cold, rationally calculated criminal activity...
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