Wednesday, February 17, 2010

Bankers and Quads, in Puerto Rico

I've been on vacation in Puerto Rico for a week. My primary source of news seems to be DVR'ed Olympics events my kids want to watch over breakfast.  There seems to be an incredible amount of talk about figure skaters falling.

Everyone talks about better scoring. Far less discretion, in theory far less corruption by the judges. Transparency.  Clear rules.  Almost sounds like bank regulation!

But, everyone seems to fall

First, any competitor faces asymmetric risks: A random slip cannot improve performance.  Quite possibly, the slip causes catastrophic failure.

Second, the Olympics is a winner take all event, more or less.  No one cares who comes in fourth or fortieth.

Third, even the best skater knows she'd have a tough time playing it safe against her weaker competitors on their luckiest days. 

You can call it skill all you want, but with so few data points (jumps in a single routine, for example,) versus massive short volatility (small errors lead to catastrophic losses) and fixed downside no matter how bad the performance (you can't do worse than "no medal"), luck will drive results.

If you want fewer falls in Olympic figure skating, you need some combination of multi-period performance and longer term downside to excessive risk taking.  But then, we all knew that, as we're demanding this of our bankers.

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