My premise is that risks evaluation often creates resource allocation and therefore a faulty risks evaluation process can quickly become ingrained in a destructive psychological feed back loops. The circular logic, closes the door to constructive criticism, and often creates bubbles and the resulting panics/downfall in individuals, companies, sectors and ultimately even economies.http://www.contingenciesonline.com/cont ... J#pg12This is my first publication in a professional journal, and I would appreciate peer review.

I did go to the URL you provided because I don't understand what you have said in your post here. What do you mean when you say that risk evaluation creates a "resource allocation"? Risk evaluation is not a costless exercise and thus it competes for resources like other activities in business. It is probably (and perhaps perversely) true that financial executives do not value a dollar saved as much as a dollar profited. Risk management people were screaming blue bloody murder in some shops but managements simply ignored them. Risk management cultural problems remain.You have touched on a number of salient issues, most notably a serious lack of competition in the supply of complex structured products (in banking in general, really) and a tendency to believe (hope?) that quantification is a silver bullet that will solve all problems. These are very real problems. Good risk management is a culture and a process, not a set of algorithms/software/reports.I think you haven't paid enough attention the fundamental principal/agent problem in banking. Once you get near the top of a large financial corporation you will get rich no matter what you do. Screw up and you are paid millions to go away. Succeed somehow and you are paid many more millions. Faced with that rosy set of outcomes, why wouldn't you roll the dice with someone else's money? And then there's the disaster put option implicitly offered by governments. Until the fundamental perverse incentive at the board room level is solved, all the regulation in the world won't mean much. You did note that rating agencies were perhaps less vigilant than they should have been because they were "competing for market share". They were in fact strongly incented to provide AAA ratings for many products because they weren't paid anything if they didn't. It was reported in the financial press that at least some of their rating models did not even accept negative values for the rate of housing price growth. In a fair world I don't think a single of these agencies would continue to exist after the dust and lawsuits settle. Forget that, though.As far as the value of actuaries, I've sat on the pension committees of banks and was continually amazed at how little the actuaries could tell me about the solvency of our pension fund. Every single simple what-if question I asked met with the same response: "give us a couple of weeks and a large bag of money and we'll figure it out for you". If I were a younger man...

Thanks for your response. "Resource allocation" often means capital or money, but also means real capital or people as well. Money and power can be potent intoxicants.Besides the problems with AIGFP's risks evaluation, there was the serious problem that you suggest: Leadership had a no personal loss position.I am implying that leadership often get their no loss positions at least in part by embracing the risks evaluation methodology and using it to their advantage. They then shut out any other method that evaluates risks differently. Of course you are right that the agency problem is bigAs for pension actuaries, they generally are a much different branch than most actuaries hired by insurance companies to model risks. But my conclusion was meant to imply perhaps some actuaries are not doing their job. Most I know manage the data and the underwriting aspects very well. I believe this expertise could have prevented much of the problems in mortgage underwriting. But of course management of those organizations had perverse incentive to not actually hire competent people to oversee underwriting. However, some actuaries do not manage up well. Some have a hard time dealing with marketing and upper management. Perhaps some are simply glad to have a voice at the table, even if it is reduced to simplistic models which they are forbidden to show where the holes are. In other words it was a call to arms.I believe managing up, is a big issue for many quant types not just actuaries.While in this forum I am preaching to the choir.

Nice article.Your Law of Risk Evaluation reminds me of "Daníelsson's corollary of Goodhart's Law" which states"A risk model breaks down when used for regulatory purposes."Your Law can perhaps be summarized as "a risk evaluation process stops working once you start using it to allocate resources in a real organization".

Very nice summary of the end results. However, I would argue how you get there and the end results combined give the potency to this "law". The result is largely due to the agency problem, if you expand individuals to include individual companies and sectors as "individuals" Putting the two ideas together has helped me predict where the next crisis will occur sometimes, at least in the insurance sector where I have some expertise. And help specific companies dodge some of those bullets. Understanding where the logic got off track gives you a fundation to argue from that is hard to beat.It would seem to me that rather than aiming regulatory response to win the last wars battles: it would be much wiser to insist that companies maintain flexibility an use multiple models and some subjectivity with uniquely tailored inputs and models in risks analysis used for allocation purposes. Focusing on last wars battles ends up mis-allocating resources.