Booklets

The Cournot Centre’s Prismes

The Impossible Evaluation of Risk

Prisme N°18

André Orléan

Prisme N°18 April 2010 (English) (446.1 KiB)

Prisme N°18 April 2010 (French) (447.9 KiB)

The current financial crisis stems from a massive under-estimation of mortgage risks, particularly of the subprime kind. This essay seeks to understand the origins of such an error. Economists most often advance the perverse incentive structure as the cause. This is a valid point, but it only provides a partial explanation. This text explores another hypothesis: the difficulty inherent in predicting the future when agents face uncertainty of a Knightian or Keynesian type. It seeks to show that economic uncertainty is of this type. Probability calculus cannot be applied to it. For that reason, economic uncertainty evades the only available method of prediction: statistical inference. Consequently, in a Knightian world, there is no such thing as an objective evaluation of risk. This point is illustrated by examining the case of the US presidential elections of 2000.

A Moment of the Probabilistic Experience – The Theory of Stochastic Processes and Their Role in the Financial Markets

Prisme N°17

Nicole El Karoui, Michel Armatte

Prisme N°17 February 2010 (English) (560.6 KiB)

Prisme N°17 November 2009 (French) (398.0 KiB)

Probabilists are often interested in the history of their discipline, and more rarely by the fundamental questions that they could ask about the facts they model. Works like Augustin Cournot: Modelling Economics, and especially the chapter by Glenn Shafer, throw light on some of my experience in the domain of probability over the last 40 years, which began in 1968, at the end of the first year of my Ph.D. They have prompted me to present my own point of view here.

I had the good fortune to participate in an extraordinary moment in the development of probability, more precisely the theory of stochastic processes. This was an unforgettable period for me. At the time, I had the feeling that I was witnessing science — probability theory — in the making. Subsequently, (rather by chance, it must be said) I switched over to the side of probability users, about 20 years ago, by focusing my research on one particular sector of finance. In the present text, I shall try to explain what interested me in the approach and in this aspect of finance on which I am still working today. To begin with, my account will be that of a pure probability theorist, and then that of an applied probabilist.

• Order free of charge – Commander sans frais

Should You Take a Risk When You Do Not Know for Sure? From Judging to Acting since Condorcet

Prisme N°16

Pierre-Charles Pradier

Prisme N°16 March 2010 (English) (513.4 KiB)

Prisme N°16 October 2009 (French) (296.1 KiB)

Condorcet proposed a principle of reasonable probability: actions entailing a prohibitive risk with a non-negligible probability should not be taken. This principle guides the development of knowledge as much as it guides the action itself. The mathematics developed by Laplace has allowed for the effective application of this principle in mathematical statistics (point estimates combined with a high confidence level) or in the management of insurance companies (calculating the loading rate to ensure the solvency of the company). During the same period, Tetens was developing related ideas – though with less mathematical efficacy. These ideas from the 18th century still apply today, both in (the interpretation of) certain modern decision models and in the informational and legal requirements that should be enforced to ensure that financial decisions are rational.

• Order free of charge – Commander sans frais