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New Risk Management Avoiding Bias and Blindness Presentation to Project Management Institute Monterey Bay Chapter March 21, 2013 Bill Wiltschko.

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Presentation on theme: "New Risk Management Avoiding Bias and Blindness Presentation to Project Management Institute Monterey Bay Chapter March 21, 2013 Bill Wiltschko."— Presentation transcript:

1 New Risk Management Avoiding Bias and Blindness Presentation to Project Management Institute Monterey Bay Chapter March 21, 2013 Bill Wiltschko

2 We are Mere Humans A.We (even statisticians) are terrible at statistical thinking B.We are worse when thinking about extreme events C.We are worse yet at understanding the game around probabilistic events Page 2 --but there are measures we can take to compensate

3 What Would You Do – Case 1? Get $900 for sure Or 90% Chance to get $1,000 Page 3

4 What Would You Do – Case 2? Lose $900 for sure Or 90% Chance to lose $1,000 Page 4

5 The Four-Fold Pattern Page 5 GainsLosses High Probability 95% chance to win $10,000 Fear of disappointment RISK AVERSE Accept unfavorable settlement e.g. Winning Litigant 95% chance to lose $10,000 Hope to avoid loss RISK SEEKING Reject favorable settlement e.g. Losing litigant Low Probability 5% chance to win $10,000 Hope of large gain RISK SEEKING Reject favorable settlement e.g. Lottery 5% chance to lose $10,000 Fear of large loss RISK AVERSE Accept unfavorable settlement e.g. Insurance

6 Which is Scarier? The risk of permanent disability from a given child vaccination is 0.001% Or One of 100,000 children will be permanently disabled by a given vaccination. Page 6

7 What is the Ratio of Deaths from These Causes? ABRatio? (A:B) StrokeAccidents TornadosAsthma LightningBotulism DiseaseAccidents Diabetes Page 7

8 Alar Love Canal Page 8

9 Boeing 787 Batteries The battery that burst into flames two months ago on a Boeing Co. 787 jet in Boston experienced dramatic power fluctuations and other failures its designers had considered practically impossible, according to the latest report by U.S. air-safety regulators. In another section, the report reiterates that Boeing initially determined that the likelihood of a 787 battery emitting smoke, without catching on fire, was one in 10 million flight hours. Page 9 Wall Street Journal, March 7, 2013, Based on NTSB Interim Factual Report 03-07-2013

10 Fukushima In a discussion of the earthquake and tsunami that produced the 2011 Fukushima nuclear disaster in Japan, Taleb writes: "Not seeing a tsunami or an economic event coming is excusable; building something fragile to them is not." And in the case of the Fukushima disaster, authorities seem to be responding appropriately: not by developing better predictive models, but by building smaller and less vulnerable reactors. Nassim Nicholas Taleb on Accepting Uncertainty, Embracing Volatility, Knowledge@Wharton, December 17, 2012 According to NRC documents, between 42 percent and 59 percent of the most risk-significant accident scenarios aren't even modeled in nuclear risk assessments. The NRC and the nuclear industry have relied on risk models that leave them half blind to the very events they're attempting to avoid. US News, July 1, 2011 Page 10

11 Black Swan The Story Black Swan characteristics – Outlier, high-consequence, rational only in retrospect One Black Swan Lesson Page 11

12 One Black Swan Lesson Absence of Evidence Evidence of Absence Page 12

13 Black Swan Quadrant Page 13 Simple PayoffsComplex Payoffs Thin-tailed distributions (e.g. Gaussian) Extremely robust to Black Swans Quite robust to Black Swans Thick-tailed distributions, or unknown Quite robust to Black Swans Limits of statistics – extreme fragility to Black Swans Complex payoff is nonlinear function of value x, say x 2 or e x or worse

14 Payoffs True and False [or right and wrong] play a poor, secondary role in human decisions; it is the payoff [benefit or harm] from the True and False that dominates – and it is almost always asymmetric. Page 14

15 Human Phenomena Are Often Not Gaussian Fat tails, e.g. Power Law Non-linear payoffs Lack of independence – Of variables, instances, and with other systems Page 15

16 Fragility Triad Page 16 TriadMeaning FragileBenefits are small and visible, negative side effects are large and invisible RobustBenefits and costs are moderate, side effects are small and visible AntifragileCost are small and visible, positive side effects are large and invisible

17 Examples Page 17 FragileRobustAntifragile Black SwanExposed to negative Black SwansExposed to positive Black Swans BusinessesBankingSi Valley: fail fast, be foolish Biological and economic systems Efficiency, optimizedRedundancyDegeneracy (functional redundancy) ErrorsHates mistakesMistakes are just informationLoves mistakes (since they are small) ScienceDirected researchOpportunistic researchStochastic tinkering (bricolage) EthicsSystem without skin in the gameSystem with skin in the gameSystem with soul in the game RegulationRulesPrinciplesVirtue FinanceDebtEquityVenture Capital Financial dependenceCorporate workerDentist, niche worker, minimum-wage worker Taxi driver, artisan, prostitute LiteratureE-bookBookOral tradition Psychological well- being Post-traumatic stressPost-traumatic growth Philosophy and science RationalismEmpiricismSkeptical, subtractive empiricism

18 What Fragility Looks Like Page 18 Zero Benefit Increasing values This is Fragility

19 What Antifragility Looks Like Antifragility implies more to gain than to lose, equals more upside than downside, equals favorable asymmetry. Equivalent to buying a put or call option Having out-sized benefit is dependent on – Recognizing antifragility – Recognizing when you have a right-half situation Page 19 Zero Benefit Increasing values

20 How To Detect Fragility Do a sensitivity analysis – For example, if add 1000 cars to traffic in a city, does drive time become linearly affected or drastically affected? – For example, if predictions are wrong by double the error band, Will the benefit/harm increase non-linearly? Will benefit increase more than harm, or vice versa? (compare results of the two sides of the error band) Page 20

21 Antifragility Lessons Fools game to guess probability or statistics of extreme events (cannot be measured or estimated) – Whats the worst that has happened in the past? – Lets use the statistics tools in Excel – All our observations are independent – We will use error bands (e.g. ± 5%) to guard against bad predictions Vulnerability can be measured and improved – Failure Modes and Effects Analysis (FMEA) – Mitigation of effects (i.e. risk) Page 21

22 Forecasting - Two Teams Page 22

23 Last Word(s) Technology is the result of antifragility, exploited by risk-takers in the form of tinkering and trial and error, with nerd-driven design confined to the backstage. Engineers and tinkerers develop things while history books are written by academics; Suggested National Entrepreneur Day message: Most of you will fail, disrespected, impoverished, but we are grateful for the risks you are taking and the sacrifices you are making for the sake of economic growth of the planet and pulling others out of poverty. You are at the source of our antifragility. Our nation thanks you. [italics in original] To be sophisticated you need to accept that you are not so. While the gene is antifragile, since it is information, the carrier of the gene is fragile, and needs to be so for the gene to get stronger. If you take risks and face your fate with dignity, there is nothing you can do that can make you small. Page 23

24 References Thinking, Fast and Slow by Daniel Kahneman Thinking, Fast and Slow Daniel Kahneman The Black Swan by Nassim Nicholas TalebBlack Swan Nassim Nicholas Taleb Antifragile by Nassim Nicholas Taleb Antifragile Nassim Nicholas Taleb Bill Wiltschko 831 596-5073 Page 24

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