Dark Side of Risk Management
How People Frame Decisions in Financial Markets

By Luca Celati
Financial Times / Pearson Education Limited
December 2004
ISBN: 0273663461
391 Pages, Illustrated, 7 ¾" x 9 ½"
$147.50 Hardcover

In practice, people are not nearly as rational as it is assumed and they make more mistakes than their egos are willing to honestly admit. Over-optimism, stubbornness, inertia.... human behavior is increasingly recognized as a factor in decisions with risk outcomes. The management of risk can no longer ignore behavior on the grounds that if you can't measure it you can't manage it. Measuring and managing the elusive human factor - the dark side - of risk is the challenge that Luca Celati takes on in this groundbreaking book.

Rather than concentrating entirely on the theory, empirical studies and academic debates, this book makes the topic more accessible for people who want to roll up their sleeves and get their hands dirty. This book will provide practical guidelines and thought processes to use inside a financial institution, typically a Bank with a trading room, dealmakers and risk managers, the latter looking at market risk, credit risk or both. What happens inside the decision-makers' heads - rather than the sophistication of the tools they use - is the prime concern here.

" Human failure - rather than models, markets or defaults - is the common trait between all the major risk disasters and financial panics of the last 20 years and why top managers never learn the lesson.
" First book to illustrate the consequences of Behavioural Finance in Risk Management, the area of institutions that is mandated with optimising risk-adjusted performance.
" First to introduce psychometric testing tools in a book on finance and risk management.
" Emphasis on practical applications in the daily risk and trading reality, rather than on theoretical or academic issues.


PART I: Theory 1 Throwing in the gauntlet
1.1 The punchline: what's in it for you?
1.2 The issue and its sub-themes
1.3 Not another behavioural finance book
1.4 Denial dies hard
1.5 It begins inside you
1.6 What this book is and what it is not
1.7 Who should read this book
1.8 About the author
1.9 Structure of the book
2 Your information risk processing
2.1 About the Questionnaire - a disclaimer
2.2 Questionnaire instructions
2.3 Briefly on your brain: information processing and physiology
2.4 Your information channels and their limitations
2.5 Your decision-making styles and motivations
2.6 Reality or frames? How do you interpret what you see?
3 Frames of risk: the concept
3.1 Frames of risk in decisions: one concept, multiple applications
3.2 Frames of risk definition
3.3 At a glance
3.4 The systemic frame of risk
3.5 The organizational frame of risk
3.6 The individual frame of risk
4 Behavioral finance and basic biases
4.1 Academic anathemas
4.2 The efficient market hypothesis (EMH)
4.3 The behavioural finance challenge
4.4 Biases basics
5 Individual biases and risk consequences
5.1 The broad picture
5.2 Representativeness and anchoring
5.3 Biased probability assessments
5.4 Self-preservation biases
5.5 Sequential information-processing bias
5.6 Symptoms of risk disorder syndrome (RDS)
6 We are not alone: group think, herding and game theory
6.1 Another challenge to conventional economics and finance
6.2 Game theory and instability in strategic interaction
6.3 Group risk biases and consequences
6.4 Group and game theory experiments and empirical studies

PART II: Practice
7 Risk framing and communication
7.1 The information fallacy
7.2 Frames in trading and portfolio decisions
7.3 Aversion to ambiguity meets risk management
7.4 Other trading frames
7.5 Risk communication
8 Riding the tiger: the trader
8.1 Psychology in the trading room: a diamond buried in the sand
8.2 The London Business School studies
8.3 Behaviour of speculators in commodity and futures markets
8.4 Additional behavioural research on other types of risk-takers
8.5 The seven cardinal sins of trading
8.6 Future indications for research
9 Risk management, financial alchemy and illusion of control
9.1 Risk management: one word, many meanings
9.2 What proper risk management really is
9.3 Frames in risk management
9.4 Key internal clients and their delusions
9.5 The external constituencies and their motivations
10 Frames in action: financial risk disasters and panics
10.1 New accidents, old mis-management
10.2 The dangerous mix of leverage and overconfidence
10.3 Houston, we have a problem: Enron
10.4 Overconfidence in processes
10.5 Markets beat overconfidence in quantitative models: LTCM
10.6 'Hot hand' and overconfidence in trading skill: Orange County
10.7 Herds and financial panics
11 Other Masterpieces outside finance
11.1 Human issues in new technology management
11.2 The Space Shuttle
11.3 Nuclear disasters
11.4 Bhopal
11.5 The Titanic

PART III: Going forward
12 So, what now?
12.1 More on your beliefs and where they can lead you
12.2 Your own mental computer - basics
12.3 Moving forward
12.4 Re-programming the background of a risk problem
13 The voice of wisdom: or is it?
13.1 Word to the Opposition
13.2 Denial = comfort
13.3 Active Resistance
14 Epilogue
14.1 Wrap-up
14.2 Individual frame of risk summary points
14.3 Organizational frame of risk summary points
14.4 Systemic frame of risk summary points
14.5 Farewell

Appendix A: Psychometric questionnaire
Appendix B: Quite some pearls of wisdom…
Appendix C: Summary of key game theory models
Appendix D: Additional tables for Chapter 7 Glossary References Further reading for practitioners

Luca Celati is the Founder and CIO at Abraxas Capital Management. Prior to founding Abraxas, he held a range of trading and risk roles. Luca has an MBA from Northwestern JL Kellogg Graduate School of Management.

Return to the Businesss Titles Home Page