Bias in Risk Assessment

If you want to be a realist, start by being a pessimist. It sounds miserable, but the psychological evidence is compelling. Most people suffer from optimism bias, and many of the rest are labelled as ‘depressed’. In short, happy and well-adjusted people generally tend to overestimate how long they will live and how successful they will be. Do not blame me for being a sourpuss – this is scientific fact, not just my contrarian nature (though perhaps I know these facts because I systematically went out and looked for evidence to support by contrarian beliefs…)

Given that most firms start with the most primitive form of risk management, which basically means just asking people what they think about risk, then you have to marvel at how the inherent problem of bias is so utterly overlooked. After all, it is called ‘risk management’ not ‘wishful thinking management’. We already know (or we should know) that if you ask people about risk, they will give you a biased answer. So how should we address this problem? In this brilliant article, Denise Tessier of Wolters Kluwer Financial Services walks through the strategies for minimizing bias in risk assessments. She gives good and straightforward advice that is well worth following. As Denise cogently observes in her conclusion:

ERM practitioners must appreciate that all human input into a risk study is subject to bias, and adopt appropriate mitigation techniques to ensure a clear, sharp view of the future.

Eric Priezkalns
Eric Priezkalns
Eric is a recognized expert on communications risk and assurance. He was Director of Risk Management for Qatar Telecom and has worked with Cable & Wireless, T‑Mobile, Sky, Worldcom and others.   Eric was lead author of Revenue Assurance: Expert Opinions for Communications Providers, published by CRC Press. He was a founding member of Qatar's National Committee for Internet Safety and the first leader of the TM Forum's Enterprise Risk Management team. Eric currently sits on the committee of the Risk & Assurance Group, and is an editorial advisor to Black Swan. He is a qualified chartered accountant, with degrees in information systems, and in mathematics and philosophy.   Commsrisk is edited by Eric. Look here for more about Eric's history as editor.
  • Eric,

    Risk is a funny animal. Prudence is important, but daring is also an extremely important element of success. Twenty years of business has proven that big telecoms are good at sailing yachts inside sheltered harbors.

    Can anyone name a single telecom or cable operator who has succeeded in a dotcom business, in software, or in wireless devices? Bold risk and putting out to sea are apparently not in the gene pool.

    It was college students and recent grads (Google, Netscape, Facebook, Yahoo, and eBay) who captured most of the internet magic. Indeed, you could argue that Apple has succeeded because its founder, Steve Jobs, never lost the wisdom of his early Macintosh years to try lots of things and take plenty of risks.

    After disappointing sales, HP pulled the plug on its WebOS devices this week after the company paid $1.5 billion to acquire Palm last year. So was that investment a big waste of money? Hindsight often makes the cynic look smart. But look at the potential upside: winning a share of the biggest product category in the world, smartphones. Hmm. HP is giving up way too early on devices, though it’s at least going to keep the WebOS operating platform alive.

    The Denise Tessier piece is splendid. And here’s a quote from another guy who was fond of taking risks and searching for the truth:

    “The tough mind is sharp and penetrating, breaking through the crust of legends and myths and sifting the true from the false… Who doubts that this toughness is one of man’s greatest needs? Rarely do we find men who willingly engage in hard, solid thinking. There is an almost universal quest for easy answers and half-baked solutions. Nothing pains some people more than having to think.”

    http://en.wikiquote.org/wiki/Martin_Luther_King,_Jr.

    The author is Martin Luther King. You (and I) were both mistaken in thinking King was simply a civil rights leader.

    I’m reminded of King because a 28 foot statue of him is being dedicated this week in Washington DC. King is forever challenging people to change their stubborn minds – even after his death. Several media articles are criticizing the King statue because the likeness is too “tough” and the sculptor is too Chinese.

    But it’s a work of pure genius — and a lesson in life, too. The visitor must walk through the Mountain of Despair (pessimism) to arrive at the Stone of Hope (optimism).

    http://en.wikipedia.org/wiki/Martin_Luther_King,_Jr._National_Memorial

  • @ Dan: that is the finest comment I’ve read in many a year. In defence of the pessimists, let me observe that optimism is not the same as imagination. We can imagine many futures, good and bad, if we have a tough mind of the type that Martin Luther King described. We can also imagine that everything is for the best, or that everything will work out fine, as we walk an obvious path that we always intended to take. That kind of imagination is akin to rationalization. How can we distinguish between penetrating imagination and rationalizing imagination? The surest way is with hindsight. People learned to trust Steve Jobs because he kept succeeding. But this is not good enough; we have no hindsight on the things we never try to do. Another way to test imagination is through inconvenience. If we imagine the truth to also be convenient, we should doubt ourselves more. If we accept that the truth may be inconvenient, and we have no settled opinion on what is the truth, we retain an open mind.

    Babies are born scientists; they have no preconceptions. Primarily they observe, and they are most interested in novel data, which does not conform to previous expectations – a new face, a different voice. They manipulate the world in order to experiment with the world, and so learn more about it. As we grow older, our expectations solidify. If we find the world does not conform to our expectations, we have many ways to explain why it really did conform, at some deeper level. The optimist keeps telling us the world is and is going to turn out well, whilst the pessimist says the opposite. Neither is right. The route to truth is to think like our baby selves: all truth is contingent, observation is key, and never stop experimenting. An experiment is a calculated risk, except that we make the venture because we expect to gain knowledge, not profit. Experiments, not opinions, lead us to the truth. This route to wisdom can be conservative and radical at the same time. Be profligate by experimenting widely and often. Be frugal by only staking a little on each experiment. Is this combination optimistic or pessimistic? As far as I can judge, it is neither. But as a strategy, it works very well. How can I say this with such certainty? From observation. Only one species evolved through turning infancy into a form of extended gathering of scientific data. That species now dominates the world.