Category / Authority and Leadership

Looking gift horses in the mouth… May 16, 2012 at 8:11 am

… is a good idea. Sallie Krawcheck writes on the HBR blog:

Because the barriers to entry are low, there’s usually no good reason why returns in an institutional banking business should stay very high for an extended period. Competition should drive those returns down. As a result, sustained high returns on equity — especially higher returns than competitors are earning — can be a sign of impending trouble. They might mean a business is taking outsized risks, or misunderstanding the risks it is taking, or is skirting too close to the regulations. Not all high-return businesses crash, but variations on the comment “In hindsight, the returns were probably too good and too steady” are all too common in the financial sector.

Update. A related issue is that high and stable returns create a huge pressure to grow the business. Then there is a risk that you become too big relative to the size of the market. As Aleph says, citing the examples of AIG, Equitable and LTCM:

Anytime you get a large fraction of the market’s volume, you should stop, and re-evaluate. You’re probably doing something wrong.

The Act part January 3, 2012 at 5:28 pm

Ever since a helpful comment by Hans on my post about what financial risk managers can learn from flight safety, I have been meaning to write about OODA loops. OODA stands for observe, orient, decide, and act; the concept is quite a helpful way of thinking about managing risk.

According to it’s inventor, USAF Colonel John Boyd, the OODA loop is a useful concept because once you figure out that this is what you are doing, you can tighten the loop and so make decisions faster than the next guy. You need to work on all four parts of the loop, and it is this segmentation which I think is most useful:

  • ‘Observe’ is obvious. Decide on your risk parameters and get the data*.
  • ‘Orient’ is more interesting. The OODA model explicitly includes a cultural element. Wikipedia quotes a Boyd paper which says that ‘the repository of our genetic heritage, cultural tradition, and previous experiences’ are ‘the most important part of the O-O-D-A loop since it shapes the way we observe, the way we decide, the way we act’. In other words, since culture is an important implicit element in decision making, you had better build it into your model of how you make decisions.
  • ‘Decide’ is also obvious. You have the data, you have analysed it based on your model of the world – figure out what to do next.
  • ‘Act’ – then do it.

The usual picture is this one (click for a larger version):

OODA loop

What we get wrong in financial risk management so often is never getting to the DA. We measure a lot of stuff. We have committees and reports and limits and such like. But the really big risks are often not acted upon because we are oriented so that we cannot decide. Look what happened to those people who tried to act against the firm’s orientation at MF Global, or Enron or HBOS.

Once a year – and why not make it the committee’s first meeting? – the group risk committee should ask themselves what features of the firm’s culture stop them from making effective risk decisions, and how they can be changed.

*Interestingly, some critiques of the OODA loop paradigm in military decision making are based on the inevitable tendency for what you observe to be narrowed to just those things that seem to help with decision making:

The result of this type of thinking is to spend a lot of time narrowing the focus of what we choose to observe in order to better orient and decide. This drives one to try and reduce the noise associated with understanding the problem.

To me, this is a risk, but not one confined to this approach. You always need to ask the question ‘what am I missing?’ in any risk measurement situation.

Great leaders realise that they have little control July 30, 2011 at 12:07 pm

In a fascinating article in the WSJ, Nassir Ghaem makes two interesting links. First he points out that many of our best leaders in difficult times were (in the clinical sense) depressed:

When not irritably manic in his temperament, Churchill experienced recurrent severe depressive episodes, during many of which he was suicidal. Even into his later years, he would complain about his “black dog” and avoided ledges and railway platforms, for fear of an impulsive jump. “All it takes is an instant,” he said.

Abraham Lincoln famously had many depressive episodes, once even needing a suicide watch, and was treated for melancholy by physicians. Mental illness has touched even saintly icons like Mahatma Gandhi and Martin Luther King Jr., both of whom made suicide attempts in adolescence and had at least three severe depressive episodes in adulthood.

Ghaem gives too many examples for us to conclude that there is no association here. So then he asks the obvious question, namely how might depression make for better leaders. His answer is rather interesting:

“Normal” nondepressed persons have what psychologists call “positive illusion”—that is, they possess a mildly high self-regard, a slightly inflated sense of how much they control the world around them.

Mildly depressed people, by contrast, tend to see the world more clearly, more as it is. In one classic study, subjects pressed a button and observed whether it turned on a green light, which was actually controlled by the researchers. Those who had no depressive symptoms consistently overestimated their control over the light; those who had some depressive symptoms realized they had little control.

For me this makes complete sense. A leader has to know what he or she can control, and what they cannot. They have to replan when things go wrong. They need strength to keep going, and belief in their cause, but also a very cleared eyed understanding of what is currently possible. So given that pragmatism seems strongly associated with individuals prone to depression, perhaps we should value these people more. Indeed, arbitrarily drawing any line between ‘normal’ and ‘mentally ill’ (as Foucault amongst many other discussed) risks discarding a huge amount of talent on the called-mad side of the line. In the good times that waste is shameful; in the bad, it is the difference between a Churchillian victory and disaster.

How long does it take a good idea to triumph? June 2, 2007 at 9:45 pm

There’s a provocative post on Econlog which raises an interesting question. Suppose someone has a good academic idea. How long does it take to be become part of the canon of accepted wisdom?

Clearly some ideas hit quickly: many of these are simple technical improvements which are obviously correct. Some never hit because, although correct, they are too boring and marginal to make a difference. Indeed some ideas enter the canon then leave it again as subject areas die: a great example here are many of the techniques used to speed tedious calculations from the days before digital computers.

As Kuhn pointed out, however, some ideas are so radical that they cannot be incorporated into the mainstream without effecting it: the paradigm must change. These ideas tend to take longer to be accepted.

I’m interested in mid-sized ideas: theories which are somewhat disruptive, but which are not big enough to qualify as paradigm changes. My suspicion is that these are slow to be accepted too, perhaps even slower than paradigm changing ideas because there is less payoff from including them, yet they still challenge the current academic hegemony. I’d love to see a careful sociological study on this. Could it be that the average time to acceptance of a such an idea is a significant fraction of a career?

The short gamma of short gamma May 20, 2007 at 5:46 pm

Very roughly, a short gamma trading strategy is one that profits from not much happening and loses a lot of money if there are big moves, whereas a long gamma strategy loses a little money every day there isn’t a big more, but makes a lot if there is.

Short gamma traders (in the widest sense) are trend followers or people who believe things will be normal. Long gamma traders want something unusual to happen.

Now here’s the thing. At the moment there is a lot of talk about a market crash being imminent. For instance, Calculated Risk is doing a good job of recording the woes of the US housing market, Nassim Taleb’s new book on long gamma has been getting a lot of publicity, and Anthony Bolton is predicting a crash. But if everyone is expecting a crash, surely this is the orthodoxy. And true long gamma traders pay to get a position that will profit if the orthodoxy does not prevail. So shouldn’t they go short gamma? And vice versa of course.

Authority in the Mediated Age December 29, 2006 at 10:08 pm

The lyric Who do you trust? is going round in my head. I need to find the song. This is the kind of thing the internet is good for. Being slightly distrustful of google and its ubiquity, I fire up and try there. Then when that doesn’t work, I tried google, and MSN, and yahoo. The trouble is not too few hits, but too many. It’s not an Eminem song I am thinking of, nor Queensryche, nor Springsteen. But that nicely illustrates what I wanted to blog about: sources of authority and web 2.0

In the old days many facts could be found in the library. The library contained the Sources of Authority, or at least it did if it was a good one. OK, it might not have been very easy to search for song lyrics for half remembered popular songs, but for standard academic stuff, it worked pretty well, especially if you had research skills. Now we have a problem, Houston.

The problem is that there are too many canons, too many places to look. How do I know who to trust? Knowledge has fractured into too many pieces: sometimes they overlap, but often they don’t. And it is too easy to claim that your corner of the world is complete, and true, and consistent. If you want to talk about cooking asparagus or the best new bands or what the cool kids in Brooklyn are wearing then the cacophony of voices is fine, authentic even. But if I want to know about the harmonic language of Debussy or homology groups or the precise rules for deciding which companies go in the FTSE-100 index, I want to read something written by someone who knows what they are talking about. The investment in figuring out who that is, though, is a lot larger than in the old days, a distinct disadvantage to the much vaulted Web 2.0 paradigm. Authority can sometimes be useful after all.

The Nature of Scientific Theories April 21, 2006 at 8:52 am

Two controversies are bubbling along at the moment which made me think about what science claims. The Evolution vs. Intelligent Design debate seems to be hotting up again, and there is controversy about climate change. Now I should immediately state that I think that Evolution is the best guess we have about how organisms developed, and that man-made factors are responsible for significant climate change that could, eventually, prove to be catastrophic. Those beliefs are supported by evidence, but that evidence is not incontrovertible.

It may be, for instance, that the Theory of Evolution will be modified and improved again. Certainly since Darwin we have seen some intriguing new ideas, such as
punctuated equilibria. So we claim too much if we say Evolution is correct. The best theory we have at the moment consistent with the evidence is more like it.

Things are even more troubling in the area of climate change. There we have rather little experimental evidence (building new planets to test climate change theories being somewhat impractical). So we just have direct measurements of the Earth’s climate, and (almost certainly correct) inferences based on things like differential oxygen isotope measurements. In addition, there are computer models of the climate, but these suffer from potential model error: they are build to calibrate correctly to known physics and known measurements, but there is enough uncertainty that their predictions about future climate may not hold, and moreover that uncertainty is difficult to quantify. That said, the overwhelming evidence both paleoclimatological and more recent is that there will be significant further global warming with catastrophic effects on mankind. But it is not certain in the same way that a prediction of Newtonian mechanics is.

In this mix, of course, we need to add significant vested interests, such as the deeply irresponsible Exxon-sponsored climate change denial, and the influence of the religious right on the abortion debate. But the best counter to this is not to overstate the claims of science. Politicians may not wish to hear carefully stated, potentially uncertain results but scientists do them, and us, a disservice if they claim a higher epistemological status than they deserve.

Finally, although scientists may wish to believe that their practice is objective, we cannot dismiss cultural factors. Kuhn’s changes of paradigm are usually accompanied by significant resistance from the scientific establishment because the figures in power have cultural capital invested in the old view. The lone scientific hero who defies the establishment to champion a correct theory is a horny old stereotype, but we should also not forget that there are many such figures who happened to be wrong. It is only eventually that we figure out who had the better guess.

Irritating and almost certainly wrong though the proponents of intelligent design and the climate change deniers are, therefore, we cannot say their ideas are absolutely incorrect. Non-scientific, politically and/or religious motivated, and unlikely to be true, certainly. Not the best guess given the evidence, undoubtedly. But not certainly wrong.