It’s said that investors learn more from their mistakes than their successes. If so, most of us are a lot wiser today compared with a year ago. If so, much of the progress in controlling cognitive bias relates to understanding risk. Such insight doesn’t come easy, nor does it insure success in the future although we’re confident that ignorance of risk eventually leads to failure.
With that in mind, consider a recently published essay by Malcolm Knight, general manager of the Bank for International Settlements. In a speech late last month, given at the Ninth Annual Risk Management Convention and Exhibition of the Global Association of Risk Professionals, he discussed what he sees as the major surprises and non-surprises that have defined much of market activity since roughly mid-2007. Perspective is no short cut to profits, but a healthy dose of historical context may save us from grief later on.
An excerpt from Malcom Knight’s Feb. 26, 2008 lecture on risk:
Some of these problems could have been foreseen, and indeed some observers had expressed strong warnings well before the turmoil. Which developments should not have come as a surprise? And what has been genuinely surprising? Let me highlight three non-surprises and three surprises.
The first non-surprise was the sharp repricing of risk that began in the middle of last year. The signs of an underpricing of risk had not been hard to discern beforehand. A month before the turmoil, we issued our BIS Annual Report for 2007 and repeated our grave concerns about the build-up of financial imbalances and their potential disorderly unwinding. Admittedly, it was impossible to predict the timing of the repricing. But the likelihood that it would occur was not. Indeed, in one respect the fact that it did occur is actually welcome: had the underpricing continued, the eventual adjustment would have been worse.