Against the Gods - a review of history of risk

The book was recommended by statistic and finance professors of IUB during college years. It wan't until after graduation that I started to read it, and its interesting stories certainly refreshed my memories of joys i had in statistical and finance classes. But as reading progressed, the book unveiled profound thoughts of the author: the evolution of human's understanding of risk and risk management.

Throughout the book, a few figures representing classic theories are given adequate exposure to readers. John Graunt established the doctrine of statistics; Daniel Bernoulli found it was imperative for a person to have probability and utility analysis in decision making; Abraham de Moivre discovered normal distribution from observation of numerous distributions of random events; Francis Galton invented regression analysis. But classic theories entail limitations. For instance, the tendency to overly rely on regression is nowhere recommended in this book. Instead, the author attributes president Hoover's failure to predict the Great Depression to excessive reliance on historical regression to forecast the future; the same attitude is given to Public's prediction of stock price in 1950S which was based on past regression and thus omitted future upward trends.

In later chapters, new theories mostly prevailed in post-WWII era emerge. Chaos theory, which challenges the regression and normal distribution theory in academic field, failed to dorminate the industry's practice in the same way as it opponents did. Another theory is Black-Scholes model, which has been used extensively for derivatives and real option valuations in derivative and stock markets. Thus, an inference from the book would be that the evolution of risk theories reflected the evolution of American economy, a transformation from manufacturing economy to service economy, in which the nature of risk has changed.

The book also raises a philosophical question of whether humans are really risk averse. The answer, according to the author, is no. Humans are not risk-averse, but loss-averse. Everyone is a loss prevention practitioner, and loss aversion guides each's daily actions. This contention is true on the ground that humans are motivated only by pursuit of happiness or avoidance of disguit. Fear of loss and uncertainty is one example of the later.

But our understanding of risk conquers the fear of unknown and leads us to accept uncertainty of life and probability in daily decision making. Such tolerance and scientific measurement of risk allow human to predict and live lives with a sense of security, which then makes religion obsolete in certain spiritual and psychological aspects. Science replacing religion to deal with fear of uncertainty is what the title "Against the gods" implies.