Posts Tagged ‘risk’
Test what you know, but avoid congruence bias
A few posts ago I discussed confirmation bias, where individuals interpret everything they experience as reinforcing their existing beliefs. It’s not surprising that humans fall prey to this trap. We have to make sense of our surroundings, so we develop mental models to do so. They’re our models, based on our mental, so it’s no surprise we think highly of them.
No model of the world can capture all of its complexity. We can model industrial processes at a certain level, but we can’t get all the way down to the interactions of individual atoms. Fortunately, we don’t have to to generate accurate depictions of reality. As statistician George E. P. Box noted, “All models are wrong, but some are useful.”
Many humans realize they will move through life more effectively by testing and updating their mental models, but you need to test your model correctly. If you test your mental models and other hypotheses through direct testing, rather than testing possible alternative models, you are experiencing congruence bias. You’re testing your model, which is great, but you’re not entertaining other ways of approaching the problem, which is not so great. In The Structure of Scientific Revolutions, Thomas Kuhn argued that scientists work within a paradigm, which is the dominant framework for creating, testing, and determining hypotheses at a given time. When experimental results aren’t as expected, scientists can either work to shore up the existing paradigm or create a new one.
My wife, Virginia Belt, is a director and formerly taught acting at Willamette University in Salem, Oregon. She emphasizes the need for actors to try different tactics to get what they want. Think of the young child who tries everything he can think of to have you buy him a treat at the grocery store or the cat that really, really (really) wants a piece of sausage from your pizza. You can take the same approach to life. If you find your model isn’t working well any more, such as after a promotion at work, joining a new improv group or entering into a new relationship, try different tactics to see what does work. Ginny always exhorts her students to make positive choices, to focus on what they want rather than what they don’t want. If you call Domino’s and say you don’t want anchovies, you’ll either get no pizza because you haven’t given them enough information or get a pizza that costs $50 because it has every other available topping on it.
As anyone who has ever tried anything new well knows, individuals who break away from the pack meet a lot of resistance. Having the strength to break out of congruence bias at a personal level is tough — having the strength to do it in the face of a tenure board is even tougher. Let’s leave the paradigmatic fights for the professionals and focus on our own world views for a while. We’ll be better off in the end.
Perceived safety increases risk-taking
In many senses, life is a series of risk/reward calculations. Choosing which school to attend, buying a house, and choosing a spouse are all risky endeavors. According to the Peltzman effect, also known as risk compensation, people have a tendency to take greater risks when perceived safety increases.
I’m sure this conclusion comes as no surprise to you. Toddlers learning to walk soon start to run, or go down stairs, with the expected results. Teen drivers (particularly teen boys) get comfortable behind the wheel and dart off in a burst of testosterone, occasionally ending up in dire circumstances. This phenomenon was very common the Formula 2 racing series. Formula 2 is a development series for the global F1 competition, which is viewed as the pinnacle of motor racing. The problem is that the Formula 2 series was plagued with multiple accidents resulting from brash moves made by the young drivers. The reason? Analysts, including current F1 drivers, argued that Formula 2 racers were overly aggressive because their cars are so safe. Romain Grosjean, a Formula 2 driver who now competes for the Renault F1 team, was fined several times and sat out for an F1 race after being at fault in repeated incidents following his promotion.
Investors make similar risk/reward calculations. Wall Street investment bankers often take significant risks because their compensation schemes reward short-term success far more than they punish failure. Why would they take such risks? Because it’s part of their overall strategy. In the Wharton School’s corporate finance MOOC I’m taking on Coursera, Professor Franklin Allen argues that one’s sense of risk is inverted when you think of investing in a portfolio of stocks rather than in a single stock. For example, imagine that you buy stock in an oil company that finds oil in 1 out of 20 wells, and each producing well returns $100. You have a hit rate of 5% which, multiplied by the return of a good well, yields an expected value of $5. Now imagine that you have a separate investment in a research company that has a 1 in 50 chance of returning $250, otherwise gaining you nothing. This investment has a similar expected value to the previous example, because 2% (1 in 50) of $250 is $5.
Which of the two investments is less risky? If you look at the expected values, they’re equally risky. However, Professor Allen argues that, when considered as part of a portfolio, the latter investment is less risky because of its higher potential return. The crux of the argument is that a diversified portfolio with numerous independent risks will tend to have a higher return than a collection of pedestrian investments with relatively low risk. The end result is safety in numbers. Just as a fair coin flipped 1,000 times will tend to show heads in about 50% of the trials, investments with independent risks will tend to earn out at their expected rate, assuming you adjudged the risks correctly in the first place. Statistics on investment return since the year 1900 bear out his argument.
Improvisers can and should take risks to make great scenes. We can do it without fear because we know our fellow players will be there to make what we say and do the right thing. Similarly, businesses can take risks as part of a diversified portfolio of ideas. Just as you wouldn’t invest in a single stock such as, I don’t know…Enron, you shouldn’t discourage experimentation and risk. That said, you must understand that risks taken within a scene or business are dependent, not independent. There’s only so much we can do to fix things if you go too far overboard. If you can’t spread out your risk, you must moderate it to be successful.
Improspectives 