The Fat Tail

I seem to just love learning about statistics and am fascinated with ideas surrounding risk. I chose to read this book (The Fat Tail: The Power of Political Knowledge in an Uncertain World: The Power of Political Knowledge in an Uncertain World by Ian Bremmer and Preston Keat) to better understand fat tail probabilities and how they play out in life.

This book discusses how investors can evaluate political risk. Stepping back, the tools it provides its reader can be used to evaluate daily life risks – from business interactions, to local political concerns, and more.

Fat Tails

A fat tail is the unexpectedly thick tails on the ends of risk distribution curves representing events that appear so catastrophically damaging, unlikely to occur, and difficult to predict that many choose to ignore them – until they happen.

Risk is the probability that any event will turn into a loss and is comprised of probability (of a negative outcome) and impact. (Risk = Probability x Impact)

  • How likely will it occur?
  • If it does occur, how impactful will it be?

Uncertainty implies the inability to determine the probability, impact, or both of a certain future event.

Risk Management works to transform uncertainty into probabilistic, measurable assessments, or risks.

How to deal with the Unknown – How to Prepare for Risk

Isolating

We can manage future risks through isolating critical assets to either lower their overall vulnerability or simply to ensure that not all are open to the same set of threats at the same time.

This is how biological diversity provides antifragility. Diversification in investments provides protection.

Smoothing

…distributing risks over time and across various theaters, business, subsidiaries, and entities.

This is diversification across time (Isolation is diversification across space.)

Warning

Warning systems and forecasting can be used to better prepare for specific contingencies.

This is preparation and a “trip wire.”

Agility

Reducing the time and costs of response to crises can substantially lower risks associated with them.

Work to improve flexibility, decrease unnecessary bureaucratic oversight, and use equipment that can be quickly moved to improve an organizations response times.

Alliances

Alliances … can help mitigate the risks inherent in uncertainty by spreading risk among them.

This is diversification of risk across partners.

Environmental Shaping

…mitigate risk by influencing the environment where [you] operate.

Strategies to Reduce the Probability of a Risk

  1. Eliminate the threat
  2. Minimize the likelihood of the threat
  3. Isolate the event
  4. Avoid the risk altogether