Let's imagine that you are one of the lucky many that gets an all-expense paid junket--uh, I mean gets to attend an important industry risk conference--in Las Vegas. After picking up your name tag and conference materials, you quickly notice that the sessions are not nearly as interesting as you had remembered them appearing while you were sitting in your office two months earlier plotting the case to convince your boss that you couldn't possibly miss this conference. And most certainly less interesting when compared to the real world of risk (and often regret) in the casinos and night clubs of Vegas beyond the conference center doors.
You quickly convince yourself that you would learn a whole heck of a lot more about taking and managing risks during this trip by "doing" versus sitting through session after session of talking heads reading bullet points and making lame opening jokes.
After ditching your name tag and changing into something a tad more comfortable (and conducive to your new "learning environment"), you stroll onto the casino floor, with an open mind and a full wallet.
You think to yourself, "Sure, I'm no professional gambler, but I'm also no dummy. I know my way around a deck of cards."
After all, you remember seeing the movie 21, and you made it three-quarters of the way through Beat the Dealer on the plane trip to Vegas. You've played numerous rounds of blackjack (games on your smart phone count, right?).
You scan the floor, order a scotch "shaken not stirred" from a waitress with a confused look on her face, and decide to meander over to a blackjack table with three other respectable-looking players and a dealer that is easy on the eyes. After exchanging a crisp $100 bill for what seems like a surprisingly puny stack of chips (four to be exact), you place your first chip on the table, and before you can even blink, you have busted and your chip is gone.
Being "no dummy," you decide to sit the next hand out and instead watch and get a better lay of the land. To your left is a couple that appears to have no interest in you. To your right, as luck would have it, is a gentleman with a modest stack of chips who looks and acts a heck of a lot like Raymond Babbitt, as played by Dustin Hoffman in Rain Man.
You decide to strike up a conversation with him by joking that he reminds you of Dustin Hoffman. He responds with an odd laugh, tells you that his name is Kim Peek, and confesses to you that he was actually the inspiration for the movie Rain Man. Just to show off a bit, he asks you for the date that you were born and immediately responds back that you were born on a Wednesday. Not knowing the answer yourself, you check the calendar on your phone and low and behold, he is right!
After pinching yourself to make sure that you were not actually daydreaming through a boring conference presentation, you ask Mr. Peek if he could teach you a thing or two about winning at blackjack. Again, he laughs, gives you a once over, and then responds, "You don't have a shot at winning. However, you seem like a nice person, how about I let you bet on me by allowing me to play your cards and chips for you, at no charge to you. You can end the arrangement at any point. Want to bet on me?"
What would you ideally want to know in order to bet on Mr. Peek, or any gambler for that matter? (Try writing down everything that you can think of.)
Because you are in Vegas, you are more than welcome to "play" on the basis of dumb luck. But because you are a more discerning individual, you consider taking a "calculated risk" approach to this situation by first asking Mr. Peek the following questions:
1. What are the "payoffs" (or range of outcomes) involved in playing each hand and making each bet? (The answer should be a monetary amount or other acceptable measure of value/utility.)
2. What is your perception of the "odds" (or probability) of each possible outcome?" (The answer must be a number between zero and 100 percent.)
3. What are your "preferences" (criteria) for betting? (Here the answer should be an array of the combination of payoffs and odds that he is willing to bet versus not bet.)
4. How much "capacity" (capital) does your betting strategy require in order to payoff over the next two hours (or however long you are willing to commit to this arrangement)? [The answer should be a monetary amount or other acceptable measure of value/utility.)
5. What is your/my access to "liquidity to additional capital"--how much and how fast--if your strategy requires more than $80 (what's left of the initial $100) in capacity? [The answer should be a combination of a monetary amount and a specific timeframe.]
What is interesting about this hypothetical situation is that it is actually not much different than when we make (or delegate) decisions in our personal or business lives. The only difference is that, if the situation with Mr. Peek presented itself and we asked the questions above, we may actually be applying a higher standard to screening Mr. Peek's decision and risk-taking credibility than we would in much more impactful situations.
For example, for an important decision you made (or delegated), when was the last time you really stopped and asked yourself--and answered--those five questions.
Rather, we typically use our gut (which we all know is subject to a whole host of common biases and errors) and look to the track record of our prior decisions to give us the confidence to act.
Unfortunately, you will never get the opportunity to belly up to a blackjack table with Mr. Peek. He passed away in December 2009. Fortunately, you will have numerous opportunities to ask these same questions to yourself and others before making or delegating important decisions in the future. And by the way, don't forget about the conference you are supposed to be attending!
DAVID M. WONG is director of enterprise risk management at CME Group, the world's largest and most diverse derivatives exchange
November 23, 2010
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