Seeing the world as it is

Jeetay Investments director Chetan Parikh reviews Dylan Evans’ Risk Intelligence

Published 6 years ago on May 24, 2014 Read

What does ‘risk intelligence’ mean? According to Dylan Evans, who has written a book with the same title, “it is the ability to estimate probabilities accurately... at the heart of risk intelligence lies the ability to gauge the limits of your own knowledge — to be cautious when you don’t know much and to be confident when, by contrast, you know a lot.”

According to the author, risk intelligence can be developed significantly under the right conditions. He contrasts the term risk intelligence with risk appetite; where risk intelligence is a cognitive capacity, risk appetite is an emotional trait that explains how comfortable people are with taking risks. So, “risk appetite governs how much risk you want to take, while risk intelligence involves being aware of how much you are taking”. Some gamblers have high risk intelligence coupled with a high risk appetite, but most successful gamblers are risk neutral. A dangerous combination would be a high appetite for risk with low risk intelligence.

Evans says that risk intelligence can be improved by repeatedly estimating the probabilities of a narrow range of events and getting feedback. He says that there are a number of psychological traits that inhibit risk intelligence — ambiguity intolerance (that is, reacting to ambiguity with feelings of uneasiness, discomfort, dislike, anger and anxiety that intrude on rational assessment); the need for psychological closure (the desire for an answer to a question — any answer, even the wrong one — rather than remaining in a state of confusion and ambiguity); the fallacy of worst-case thinking (transforming low-probability events into complete certainties whenever the events are particularly scary); the all-or-nothing fallacy (the tendency to think of proof, knowledge, belief in binary terms); behavioural finance heuristics such as the availability heuristic and wishful thinking (people with high risk intelligence see the world as it is, not the way they would like it to be). 

In addition to this, there are several other common errors of judgement, such as optimism bias, confirmation bias, hindsight bias and the illusion of transparency (the assumption that others have the ability to read us more accurately than is the case). 

The author believes that “true risk intelligence involves a curious blend of rational numerical calculation and intuitive (epistemic) feelings in which neither is sufficient on its own”. High risk intelligence depends upon 1) a well-calibrated epistemic feeling and 2) an ability to translate epistemic feelings into numbers. Resolution is the psychological word relevant here — how many probability ranges can we have in our epistemic thermometer?

These concepts make the book well worth reading.