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Red-Blooded Risk: The Secret History of Wall Street by Aaron Brown

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CHAPTER 6

Exponentials, Vampires, Zombies, and Tulips

This is one of those chapters that might not seem to belong in a book on risk. It turns out, however, that you have to understand exponentials in order to understand risk. One reason is that exponentials underlie most of the big positive and negative surprises in life. Things that don't change don't cause risk and don't create dangers and opportunities. Things that move or grow at steady rates are easy to manage with deterministic rules; you don't need to consider risk. Exponentials can change from too small and too slow to notice to too big and too fast to survive, before you can react. Or, if you're lucky, they can change from too small and too slow for others to notice to big and fast enough to fulfill your wildest dreams, before others can horn in on your opportunity. So learning how to spot exponentials early is crucial for any risk taker.

The second reason is that exponentials are the best way to manage risk. If you have a single big choice—the lady or the tiger, for example—there's no management involved. As the saying goes, you pays your money and you takes your chance. To manage risk we have to chop it up into many little risks. In textbooks, you can then arrange all the little risks in carefully calibrated sizes in an optimal order to maximize your expected utility. In reality, with real risk, you have to make a series of decisions without knowing exactly what the future risks will be, what all the possible outcomes ...

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