Gambling has been around for centuries. Various forms have been found in ancient China sites dating back to about 2300 B.C. A pair of ivory dice made sometime before 1500 B.C. have been found in Egypt. There has even been writings found that have been discovered on a tablet in one of the pyramids at Giza. Inhabitants of ancient India, Greece and Rome also practiced some form of gambling. So why am I writing about gambling? It’s all about risk management. It’s how we deal with this in our everyday lives, and how it applies to so many different types of business activities that we encounter on a regular basis.
Risk management is very similar to the game of Risk. The objective is to “reduce different risks related to a preselected domain to the level accepted by society.” Society being either yourself, someone you answer to, or a business entity. As applied to corporate finance, risk management is “the technique for measuring, monitoring and controlling the financial or operational risk on a firm’s balance sheet.” Have I bored you yet? Then let’s get back to the gambling.
Back in the 17th century, a man by the name of Chevalier de Mere, who had a taste for both mathematics and gambling, challenged the famed French mathematician, Blaise Pascal to solve a puzzle. The question was how to divide the stakes of an unfinished game of chance between two players when one of them is ahead. The puzzled confounded Pascal. The question actually arose around 200 years earlier by the monk Luca Passioli, who also brought double-entry bookkeeping. So a simple wager by a couple of drunk mathematicians, arose to the discovery of the theory of probability, the mathematical heart of the concept of risk.
Ever heard the phrase, “don’t put all your eggs in one basket?” In 1952, a young graduate student named Harry Markowitz, while studying at the Univ of Chicago, demonstrated mathematically why putting all your eggs in one basket is an unacceptably risky strategy and why diversification is the nearest an investor or business manager can ever come to a free lunch. That revelation launched an intellectual movement that revolutionized Wall Street, corporate finance, casino gambling and business management around the world.
The solution meant that people could for the first time make decisions and forecast the future with the help of numbers. The dice at the roulette wheel, the stock and bond market, are the perfect gaming tables for the study of risk because it all leads back to quantification. We hold our breath when the little white ball bounces about the spinning roulette wheel, and when we call our brokers to buy or sell some shares of stock, our heart is beating along with the numbers. Risk is a choice rather than a fate. The actions we dare to take, which depend on how free we are to make choices, are what the story of risk is all about…
The Finance Pig, LLC 