Chaos and Risk Management

Article excerpt

The emergence of chaos theory as a new science presents an opportunity to enhance risk management. This paper borrows the structure and terminology of modern chaos theory and lends it to the risk management practitioner. While the ultimate consequence of linking "chaos" and "risk" is indeterminable, risk managers can gain a new perspective by examining how chaos and risk persist in disrupting each another. From this disruption (and in the true spirit of chaos theory) a discernible pattern emerges.

What is Chaos Theory?

The dictionary defines chaos as "... utter confusion or disorder." Unfortunately, this generic definition of chaos creates needless confusion when used in connection with chaos theory. Chaos theory means quite the opposite. It is a new science based on the simple principle that order can be found in disorder. However, it is not a science in the traditional sense. It picks up where classical science leaves off. It is not concerned with rules and order, but rather with rules of disorder and events that appear random. It focuses on phenomena that are unpredictable, follow no known rules, have no logical consequence and seem to defy rational description. In short, it is not unlike decisions made under conditions of extreme uncertainty. it is not unlike risk management.

Hot Links to Risks Management

Aside from the theoretical appeal cited in the previous paragraph, there are several "hot links" between chaos theory (chaos) and risk management (risk):

1 Current chaos literature makes references to insurance. After all, insurance replaces the discomfort of chaotic events with a form of assurance, comfort and (at a minimum) financial order.

2 Preliminary research has uncovered individuals who were preoccupied with chaos - and linked to the insurance industry. The most notable is Wallace Stevens. Mr. Stevens lived in Hartford, Connecticut, from 1879 to 1955 and pursued a career as an insurance executive. He is most noted, however, as an American poet who wrote eloquent, philosophic verse often concerned with creating order from chaos - a fundamental tenet of chaos theory.

3 In April 1992, well after chaos first appeared in the minutes of the Risk Management Roundtable, Robert Brown, principal consultant for KPMG Management Consulting, while speaking at the Association of Insurance & Risk Managers in Industry & Commerce conference in Cambridge, England, said: "If we're in risk management, we should look around and see what's going on ... and see a science to chaos." "There may be patterns to certain types of random situation," he said. "This art can be applied to risk management."

4 Monte Carlo Theory is an interesting precedent. It demonstrates the frustration of risk management - trying to predict the unpredictable, seeking order out of disorder.

5 The Foundation for the Study of Cycles Inc., in an article entitled "Chaos and Cycles" by Martin A. Armstrong, begins with the statement: "In many ways, the science of chaos is not that far removed from fundamental analysis, in which one seeks to solve the cause-and-effect dilemma."

6 In December 1987, the French association ACADI (Association des Cadres Dirigeants de l'industrie) invited 500 industry managers, political leaders and distinguished experts to participate in an international meeting, held in the UNESCO headquarters in Paris, around the theme: "The technological risks." As a result of the meeting, a new "transverse" science emerged: the science of risks, which the ACADI chairman, G.Y. Kervern, proposed to call cindynics, from the Greek word kindunos - "danger" in French, "hazard" in English.

In March of 1990, the Institut Europeen de Cindyniques was established with the objective to offer to all risk specialists a place where they could meet, exchange views, perform indepth analyses and suggest actions, independently from any cultural, ideological or commercial link - whether the hazards they are concerned with are industrial or natural, related to large plants or diffuse. …

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