The Flaw of Averages: Why We Underestimate Risk In The Face Of Uncertainty

  • 5h 33m
  • Sam L. Savage
  • John Wiley & Sons (US)
  • 2009

A must-read for anyone who makes business decisions that have a major financial impact.

As the recent collapse on Wall Street shows, we are often ill-equipped to deal with uncertainty and risk. Yet every day we base our personal and business plans on uncertainties, whether they be next month’s sales, next year’s costs, or tomorrow’s stock price. In The Flaw of Averages, Sam Savage—known for his creative exposition of difficult subjects—describes common avoidable mistakes in assessing risk in the face of uncertainty. Along the way, he shows why plans based on average assumptions are wrong, on average, in areas as diverse as healthcare, accounting, the War on Terror, and climate change. In his chapter on Sex and the Central Limit Theorem, he bravely grasps the literary third rail of gender differences.

Instead of statistical jargon, Savage presents complex concepts in plain English. In addition, a tightly integrated web site contains numerous animations and simulations to further connect the seat of the reader’s intellect to the seat of their pants.

The Flaw of Averages typically results when someone plugs a single number into a spreadsheet to represent an uncertain future quantity. Savage finishes the book with a discussion of the emerging field of Probability Management, which cures this problem though a new technology that can pack thousands of numbers into a single spreadsheet cell.

About the Author

Sam L. Savage is a consulting professor in Stanford University’s School of Engineering and a fellow of the Judge Business School at Cambridge University.

He received a PhD in the area of computational complexity from Yale University in 1973, spent a year at General Motors Research Laboratory, and then joined the management science faculty of the University of Chicago Graduate School of Business. Here he quickly realized that an algebraic curtain separated management from management science, and he abandoned the field as moribund. Then a decade later, with the advent of the personal computer and electronic spreadsheet, the algebraic curtain began to fall, and Sam was reborn as a management scientist. In 1985, he collaborated on the first widely marketed spreadsheet optimization package, What’s Best! , which won PC Magazine’s Technical Excellence Award. In 1990 Sam came to Stanford, where he continues to teach and develop management science tools in an algebra-free environment.

His primary research focus is on enterprisewide communication and management of uncertainty and risk. In 2006, in collaboration with Stefan Scholtes (of Cambridge University) and Daniel Zweidler (then of Shell and now with Merck & Co.), Dr. Savage formalized the foundations of Probability Management and is the chairman of ProbabilityManagement.org. Recently he led a consortium that included Frontline Systems, Oracle Corp., and SAS Institute in the development of the DIST ™ Distribution String, a new computer data type for storing probability distributions.

He has published in both refereed journals and the popular press, with articles in the Harvard Business Review, The Journal of Portfolio Management, Washington Post, and ORMS Today. Sam also consults and lectures extensively to business and government agencies and has served as an expert witness.

In this Book

  • The Flaw of Averages—Why We Underestimate Risk In The Face Of Uncertainty
  • Preface
  • Introduction—Connecting the Seat of the Intellect to the Seat of the Pants
  • Foundations
  • The Flaw of Averages
  • The Fall of the Algebraic Curtain and Rise of the Flaw of Averages
  • Mitigating the Flaw of Averages
  • The Wright Brothers Versus the Wrong Brothers
  • The Most Important Instrument in the Cockpit
  • MINDles Are to MINDs What HANDles Are to HANDs
  • Mindle 1: Uncertainty Versus Risk
  • Mindle 2: An Uncertain Number Is a Shape
  • Mindle 3: Combinations of Uncertain Numbers
  • I Come to Bury Sigma, Not to Praise it
  • Mindle 4: Terri Dial and the Drunk in the Road
  • Who Was Jensen and Why Wasn’t He Equal? The Nuts And Bolts Of The Strong Form Of The Flaw Of Averages
  • Mindle 5: Interrelated Uncertainties
  • Decision Trees
  • The Value of Information—Because There Isn’t Anything Else
  • The Seven Deadly Sins of Averaging
  • The Flaw of Extremes
  • Simpson’s Paradox
  • The Scholtes Revenue Fallacy
  • Taking Credit for Chance Occurrences
  • Applications
  • Your Retirement Portfolio
  • The Birth of Portfolio Theory: The Age of Covariance
  • When Harry Met Bill(y)
  • Mindles for the Financial Planning Client
  • Options: Profiting from Uncertainty
  • When Fischer and Myron Met Bob: Option Theory
  • Prices, Probabilities, and Predictions
  • Holistic Versus Hole-istic
  • Real Portfolios at Shell
  • Real Options
  • Some Gratuitous Inflammatory Remarks on the Accounting Industry
  • The DNA of Supply Chains
  • A Supply Chain of DNA
  • Cawlfield’s Principle
  • The Statistical Research Group of World War II
  • Probability and the War on Terror
  • The Flaw of Averages and Climate Change
  • The Flaw of Averages in Health Care
  • Sex and the Central Limit Theorem
  • Probability Management
  • The End of Statistics as You Were Taught It
  • Visualization
  • Interactive Simulation: A New Lightbulb
  • Scenario Libraries: The Power Grid
  • The Fundamental Identity of SLURP Algebra
  • Putting It into Practice
  • The CPO: Managing Probability Management
  • A Posthumous Visit by My Father
  • Red Word Glossary
  • Notes
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