Behavioural Issues with Probability
Preface
An Introduction to Behavioural Risk Management
Risk Management Context
Value-at-Risk as the Dominant Risk Management Tool in the Financial Industry
Case Studies on Risk Management Failure
The Role of Regulation in Risk Management
Advances in Behavioural Economics and Finance
Behavioural Issues with Probability
Systems Theory
Using Scenarios
Making Robust Decisions
Advances in the Risk Management Process
Behavioural Risk Management in the Financial Markets
Countervailing Power
Behavioural Risk Management: Closing Thoughts
Appendix: Selective list of Behavioural Biases
Bibliography
In Chapter 2, we defined risk as “the effect of uncertainty on objectives”. Often, these uncertainties can be expressed in probabilities. After the human biases we discussed in the previous chapter, the current chapter will explore biases that relate to how human beings deal with the concept of probability and statistics. Despite our time spent in statistics class, human beings have great difficulty managing concepts of chance and probability. In descriptive statistics, we often confuse the mean or average with the dispersion around the mean. For instance, if a river is on average 1.5 meters deep, would it be wise to cross it without knowing how to swim? This would be especially unwise if the middle of the river is deep because it is meant for larger cargo boats.
Many risk managers in the second line of defence (see Chapter 13) deal with statistical concepts in which probability takes a central place. As with other economic topics, human beings are biased when it comes to dealing with probabilities and statistical concepts. This is not just because some of the topics are difficult to explain, as we will see in this chapter.
Figure 7.1 provides an overview of the behavioural
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