The Six Mistakes Executives Make in Risk Management

Black Swan events are almost impossible to predict. Instead of perpetuating the illusion that we can anticipate the future, risk management should try to reduce the impact of the threats we don’t understand.

by

Nassim N. Taleb, Daniel G. Goldstein, and Mark W. Spitznagel

by

Nassim N. Taleb, Daniel G. Goldstein, and Mark W. Spitznagel

From the Magazine (October 2009)

Summary.

Reprint: R0910G

Taleb (who wrote the best-selling books Fooled by Randomness and The Black Swan) and his coauthors argue that conventional risk-management textbooks don’t prepare us for the real world. For instance, no forecasting model predicted the impact of the current economic crisis.

Managers make six common mistakes when confronting risk: They try to anticipate extreme events, they study the past for guidance, they disregard advice about what not to do, they use standard deviations to measure risk, they fail to recognize that mathematical equivalents can be psychologically different, and they believe there’s no room for redundancy when it comes to efficiency.

Companies that ignore Black Swan (low-probability, high-impact) events will go under. But instead of trying to anticipate them, managers should reduce their companies’ overall vulnerability.

We don’t live in the world for which conventional risk-management textbooks prepare us. No forecasting model predicted the impact of the current economic crisis, and its consequences continue to take establishment economists and business academics by surprise. Moreover, as we all know, the crisis has been compounded by the banks’ so-called risk-management models, which increased their exposure to risk instead of limiting it and rendered the global economic system more fragile than ever.

A version of this article appeared in the October 2009 issue of Harvard Business Review.

NT

Nassim N. Taleb is the Distinguished Professor of Risk Engineering at New York University’s Polytechnic Institute and a principal of Universa Investments, a firm in Santa Monica, California. He is the author of several books, including The Black Swan: The Impact of the Highly Improbable (Random House, 2007). Daniel G. Goldstein is an assistant professor of marketing at London Business School and a principal research scientist at Yahoo. Mark W. Spitznagel is a principal of Universa Investments.

The Six Mistakes Executives Make in Risk Management

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