Risking it all

I, at any rate, am convinced that He (God) does not throw dice,” Albert Einstein is believed to have said. Risk is not merely confined to the game of dice — it is the game of life. That is the initial impression one gets while reading Peter Bernstein’s works. Bernstein’s earlier book, Ideas, emerged from the initial assumptions in neoclassicism: that investors are rational and markets are efficient. In searching for the origins of such ideological positions in positivist neoclassicism, Against the Gods serves as a prequel to Ideas. There’s no doubt that modern finance emerged from the neoclassical thought process, which is positivist and reductionist. In this book, Bernstein cuts through the flesh and bones of the emerging ‘science’ of finance and explains the origins of the rationality assumptions that have led to such reductionism. 

The idea behind this book is that at the fountainhead of modern society lies a clinical understanding of risk and ways to manage it in an even more clinical manner.

The author moves in a chronological order, starting from around 1200 AD to the present, giving the narrative a historical flavour. It is also biographical, with the chapters containing a series of vignettes on contributors to the subject, such as Cardano, Pascal, Fermat, Graunt, the Bernoullis, De Moivre, Bayes, Laplace, Galton, Keynes, von Neumann, Baumol, Knight, Markowitz, Leland, Rubinstein and Thaler.

Why is risk and its management a subscription to atheism? Bernstein offers an interesting response. The origin of modern thinking, according to his thesis, lies with a volte-face in primate human beliefs of events being results of divine interventions, and embracing the notion that risks can occur and need to be managed by humans, who are rational and independent agents. In a world committed to fatalism and divine origin theories, sentiments prevailed over logic, and the use of letters for numbers inhibited man’s ability to calculate. The 13th century witnessed the advent of new tools that helped in measurement and provided the initial insights into the laws of chance: the Hindu-Arabic numbering system, algebra, accounting, etc. Over time, there was enhancement in human understanding of the role that risk plays in choices humans face and make. Here lay the fountainhead of modern decision theory, which Bernstein chronicles over time.

Bernstein is not a trained historian — he need not be one. The deep-rooted understanding of risk and its entrenchment in behavioural finance is what Bernstein quests to understand and to make his readers understand. In this attempt to depict the rise of risk management, by combining many different strands in a long and complex story, he certainly succeeds.