Iceberg Risk: An Adventure in Portfolio Theory

Rating:
Summary: A Fresh & Imaginative Approach to Risk Management
Review: "Ignorance is Blight"... Devlin Advogado's scrawled message across his desk left me with an unsettled feeling, similar to the one I had a long time ago while reading Robert Pirsig's 'Zen and the Art of Motorcycle Maintenance'. Perhaps academic research will someday quote from Kent Osband's 'Iceberg Risk' (New York: Texere, 2002), much as Richard Roll, in his famous 1977 Critique of tests of the CAPM, quoted from Pirsig. Osband endeavors to help us avoid blight in this enlightening and entertaining story as we follow supersharp risk analyst Devlin and his pragmatic manager, Conway Wisdon, on a wild ride through the world of investment banking risk management.

But Iceberg Risk is more than a novel; indeed, it is really two books in one: each chapter covers the intuition of its subtopic first, through the clever device of Devlin and Conway's saga within Megabucks Investment Bank; and then delves more directly into the mathematics. Of the math, the reader is encouraged to explore "about as much or as little as you want", a feature I especially appreciated given my low-calorie mathematical diet. And, just as the novel part is an entertaining read, the quantitative part is a useful summary of the mechanics of portfolio management theory.

Part I of Iceberg Risk covers the statistics of probability, covariance and correlation, Pascal's triangles and Bernoulli variables, IID versus non-IID estimates of tail risk, Tchebyshev's inequality, the Kuhn-Tucker conditions for the solution to a Lagrangean optimization, mixtures of discrete and continuous probability measures, De Finetti's theorem, the problems with VaR and the ubiquitous (in finance) normality assumption, and even computer sex (read the book!). Osband gives us a quick introduction to matrix math (though it is even more sparse than the helpful section in Markowitz' 1959 book) before concluding the first half of the book with conditional multivariate normality.

Part II of Iceberg Risk offers a unique and thoughtful approach to overcoming the deficiencies of standard risk assumptions for portfolio management. In this part of the book Osband covers convex and nonconvex utility, regret aversion, choice theory, the appraisal ratio of Treynor-Black and even delves into the Bayesian approach to statistics. Partition functions are introduced as a method of combining conditional return distributions with multi-regime risk aversion. Without resorting to Monte Carlo simulation techniques, Osband proposes a numerical approach to generating risk estimates, since there is no closed-form equation available to solve the issue. He even shows how to account for options and other nonlinear payoff assets.

Osband's approach to risk management is fresh and appealing. It would be worthwhile reading for risk managers and portfolio managers. One aspect I liked very much about his writing style is that the characters represent very distinct human traits, much like those of another of my favorite authors, Ayn Rand. For example, we are introduced to the concept of regret aversion when Conway meets Regretta:

"He spun around to see a raven-haired woman dressed in black. She was beautiful, but with the saddest eyes Conway had ever seen. `Pardon me for eavesdropping,' she said, `But if Dr. Know-nothing can't help you, maybe I can.' `Go away, Misery Girl,' snapped Devlin. `We don't need you.' `Oh, I think you do,' she said... `Now here's what I think you need to do. First measure every outcome in terms of its gross percentage return... Second, square that return and take the negative inverse. Third, form the probability-weighted average of the various negative inverses. Fourth, pick the portfolio that generates the highest probability-weighted average. Am I being clear?' Devlin and Conway were blown away. `She does math,' mumbled Devlin to himself."

Osband makes the observation that "The mainstream seems less interested in managing risk than the appearance of risk." Readers of Osband's Iceberg Risk might just become a bit less mainstream for the reading.

Rating:
Summary: A Fresh & Imaginative Approach to Risk Management
Review: "Ignorance is Blight"... Devlin Advogado's scrawled message across his desk left me with an unsettled feeling, similar to the one I had a long time ago while reading Robert Pirsig's 'Zen and the Art of Motorcycle Maintenance'. Perhaps academic research will someday quote from Kent Osband's 'Iceberg Risk' (New York: Texere, 2002), much as Richard Roll, in his famous 1977 Critique of tests of the CAPM, quoted from Pirsig. Osband endeavors to help us avoid blight in this enlightening and entertaining story as we follow supersharp risk analyst Devlin and his pragmatic manager, Conway Wisdon, on a wild ride through the world of investment banking risk management.

But Iceberg Risk is more than a novel; indeed, it is really two books in one: each chapter covers the intuition of its subtopic first, through the clever device of Devlin and Conway's saga within Megabucks Investment Bank; and then delves more directly into the mathematics. Of the math, the reader is encouraged to explore "about as much or as little as you want", a feature I especially appreciated given my low-calorie mathematical diet. And, just as the novel part is an entertaining read, the quantitative part is a useful summary of the mechanics of portfolio management theory.

Part I of Iceberg Risk covers the statistics of probability, covariance and correlation, Pascal's triangles and Bernoulli variables, IID versus non-IID estimates of tail risk, Tchebyshev's inequality, the Kuhn-Tucker conditions for the solution to a Lagrangean optimization, mixtures of discrete and continuous probability measures, De Finetti's theorem, the problems with VaR and the ubiquitous (in finance) normality assumption, and even computer sex (read the book!). Osband gives us a quick introduction to matrix math (though it is even more sparse than the helpful section in Markowitz' 1959 book) before concluding the first half of the book with conditional multivariate normality.

Part II of Iceberg Risk offers a unique and thoughtful approach to overcoming the deficiencies of standard risk assumptions for portfolio management. In this part of the book Osband covers convex and nonconvex utility, regret aversion, choice theory, the appraisal ratio of Treynor-Black and even delves into the Bayesian approach to statistics. Partition functions are introduced as a method of combining conditional return distributions with multi-regime risk aversion. Without resorting to Monte Carlo simulation techniques, Osband proposes a numerical approach to generating risk estimates, since there is no closed-form equation available to solve the issue. He even shows how to account for options and other nonlinear payoff assets.

Osband's approach to risk management is fresh and appealing. It would be worthwhile reading for risk managers and portfolio managers. One aspect I liked very much about his writing style is that the characters represent very distinct human traits, much like those of another of my favorite authors, Ayn Rand. For example, we are introduced to the concept of regret aversion when Conway meets Regretta:

"He spun around to see a raven-haired woman dressed in black. She was beautiful, but with the saddest eyes Conway had ever seen. 'Pardon me for eavesdropping,' she said, 'But if Dr. Know-nothing can't help you, maybe I can.' 'Go away, Misery Girl,' snapped Devlin. 'We don't need you.' 'Oh, I think you do,' she said... 'Now here's what I think you need to do. First measure every outcome in terms of its gross percentage return... Second, square that return and take the negative inverse. Third, form the probability-weighted average of the various negative inverses. Fourth, pick the portfolio that generates the highest probability-weighted average. Am I being clear?' Devlin and Conway were blown away. 'She does math,' mumbled Devlin to himself."

Osband makes the observation that "The mainstream seems less interested in managing risk than the appearance of risk." Readers of Osband's Iceberg Risk might just become a bit less mainstream for the reading.

Rating:
Summary: Finding the Hidden Risks
Review: Financial professionals of all stripes will enjoy this entertaining book. Value-at-Risk (VAR), the most common risk management technique misses hidden risks.

If we use the model for a normal distribution, a five-standard deviation credit loss event should only happen once in every 7,000 years, but in the market place, we see this happen once or twice in a decade. A book that talks about hidden risk and the deficienies of VAR in capturing credit risk is another very entertaining read by Tavakoli called "Credit Derivatives" (Second Edition).

Rating:
Summary: Good read, not priced well ;-)
Review: I really enjoyed this book. I don't believe that my review can add much value on top of the other reviews, but maybe I can entice a few of you to buy it.

I have read the book twice now, which I think is required (at minimum) to really absorb everything. I see that Aaron's review got 2 out of 5, and I am a bit perplexed, because his is succinct and accurate. Oh well, you can't win 'um all. One pro is that the book is written in an entertaining way. Half the chapters are a story with a lesson, and the other half is math. Together they read like some popular books that are out now, like Havil's "Gamma", or "Euler" by Dunham: it reads like a book, but with equations everywhere. It is the half way point between a publication and a novel. If you are a masters in finance or an MBA, with no real math background, this might be distracting and halting, but to a quant it should cut like butter.

My only complaint, and this might not be a complaint but, rather, an aversion to suspense, is that there are certain thoughts that aren't completed. As interesting as the read is, I feel like it is almost a cliffhanger; baiting for books to come? I don't think this was deliberate. Some thoughts, while they began with fireworks, just petered out.

Also, it is a bit expensive but, hey, most of us aren't paying for this and, at a minimum, writing it off ;-) (Sorry to any students out there, I owe you a drink)

Rating:
Summary: Good read, not priced well ;-)
Review: I really enjoyed this book. I don't believe that my review can add much value on top of the other reviews, but maybe I can entice a few of you to buy it.

I have read the book twice now, which I think is required (at minimum) to really absorb everything. I see that Aaron's review got 2 out of 5, and I am a bit perplexed, because his is succinct and accurate. Oh well, you can't win 'um all. One pro is that the book is written in an entertaining way. Half the chapters are a story with a lesson, and the other half is math. Together they read like some popular books that are out now, like Havil's "Gamma", or "Euler" by Dunham: it reads like a book, but with equations everywhere. It is the half way point between a publication and a novel. If you are a masters in finance or an MBA, with no real math background, this might be distracting and halting, but to a quant it should cut like butter.

My only complaint, and this might not be a complaint but, rather, an aversion to suspense, is that there are certain thoughts that aren't completed. As interesting as the read is, I feel like it is almost a cliffhanger; baiting for books to come? I don't think this was deliberate. Some thoughts, while they began with fireworks, just petered out.

Also, it is a bit expensive but, hey, most of us aren't paying for this and, at a minimum, writing it off ;-) (Sorry to any students out there, I owe you a drink)

Rating:
Summary: A book for all seasons
Review: Iceberg risk describes in clear terms the financial risk that is missed by standard techniques. It is essential reading for anyone in financial risk management, as well as anyone interested in the quantitative reason for extreme financial events. It is an entertaining novel that gives a realistic picture of how risk management works in real institutions, a rigorous and original work of mathematics and a solid textbook that builds results step-by-step from basic algebra. This triple nature makes the book suitable for everyone from mathphobes to serious quants.

Rating:
Summary: Original & Entertaining: Risk in the post-'Normal' age!
Review: one of the few truly original works i've seen in my yrs as a risk manager! this work goes well beyond the standard re-hashing of the much hackneyed debate surrounding Var & deficiencies of existing measures.
novel format does a great job of conveying intuition & bridging chasm b/n ivory tower musings & the industry politics of accepting good ideas. There are key practical insights on many aspects of risk & portfolio mgt. Treatment of ExpUtility framework & Cond normality is good.

Rating:
Summary: Original & Entertaining: Risk in the post-'Normal' age!
Review: one of the few truly original works i've seen in my yrs as a risk manager! this work goes well beyond the standard re-hashing of the much hackneyed debate surrounding Var & deficiencies of existing measures.
novel format does a great job of conveying intuition & bridging chasm b/n ivory tower musings & the industry politics of accepting good ideas. There are key practical insights on many aspects of risk & portfolio mgt. Treatment of ExpUtility framework & Cond normality is good.