Financial Risk Management For Dummies

Chapter 2

Understanding Risk Models

In This Chapter

Flipping coins and betting on possibilities

Spinning the wheel in predicting outcomes

Exploring scientific risk theories

Risk management is a quantitative discipline, which means that it works with models of risk rather than risk directly. Choosing the right model is crucial. Most people make errors in risk management because they’ve no quantitative model of risk. Experts, by contrast, often make errors by being wedded to an inappropriate model of risk.

Risk managers must understand the common risk models, especially their flaws. This chapter explains many of the risk models you can use to support your risk management decisions, and how to spot errors in existing risk management frameworks.

Comparing Frequentism and Bayesianism

A famous scene in the film Zero Dark Thirty involves the director of the Central Intelligence Agency conferring with some subordinates about whether Osama bin Laden is in a house the agency has identified in Pakistan. “I’d say there’s a 60 per cent probability he’s there,” says the deputy director. What exactly does that mean?

The most common interpretation of probability statements among quantitative people ...