Statistical Risk and its Treatment

A great deal of day-to-day risk management, be it on a personal, business or community level, proceeds “statistically”. That is, we attempt to make sense of random or chance phenomena using averages and other representations that allow us to make reasonable decisions over time. We will see that much of what we call “risk” is amenable to statistical treatment in terms of aggregates over time. This allows us to identify the best, or optimal, course of action with respect to these risks using basic economic theory. The same principles we apply to rational optimization, in business and in life in general, apply to statistical risks. The statistical nature of many risks also permits verification of our results over time. Statistical analysis does have boundaries of applicability, however. We must be very careful not to extend statistical analysis beyond these boundaries. To understand, and manage, the full spectrum of risks we deal with, we must understand both the strengths and the very real limitations of the statistical approach.