EconTalk

Luca Dellanna on Risk, Ruin, and Ergodicity

Mon May 29 2023

Luca Delano discusses his book "Argodysity" and the concept of risk-taking in achieving success, using skiing as an example. He emphasizes that avoiding career-ending injuries is crucial for long-term success, and managing risks is important in achieving this. Delano also warns against survivorship bias, where we only see the successful individuals who have avoided harm or injury, while ignoring those who have dropped out or been harmed due to their obsession with winning.
The optimal level of risk-taking depends on the time horizon and different strategies may be optimal for different time horizons. You only get the average if you're allowed to continue to play, so it's important to avoid ruin or game over. Survivorship bias can lead us to overlook the downside of taking risks in pursuit of success.
The pursuit of being number one often requires taking risks that decrease the most likely outcome, and it's important to be aware of this trade-off. Many people aim for a good distribution of results, not necessarily being number one, but ending up in the top 10%. Life often involves risks similar to Russian roulette, where there is a chance of negative outcomes that cannot be averaged out. It's important to be aware of these risks and take breaks when necessary to avoid jeopardizing health or relationships.
Irreversibility is a key factor in differentiating risks that can be taken and those that should be avoided, as it means that the relationship or situation cannot be repaired if it ends. Ethical decision-making involves treating situations as if there is skin in the game beyond formal tenure, and being aware of incentives that may push risk into the future.
The concept of considering two parties with different time horizons and ensuring each party cares about the other's time horizon can be applied in various situations. The distinction between individuals and populations is important to consider when thinking about risks to society or the world, such as with artificial intelligence or a potential deadly pandemic. It is crucial to think about long-term consequences and cumulative probabilities when making decisions that could have significant impacts.
Near misses are a profound concept in safety culture, and it's important to pay attention to them to prevent future accidents. Companies can signal their commitment to safety by making it an objective that cascades down the hierarchical line and affects bonuses. Punishing near misses can help individuals think about risk, as seen in certain sports where players may be ejected for getting close to dangerous situations.
Local failures are just as important as system-wide failures in risk management. The capacity to adapt and redistribute load is crucial in preventing local failures. Variance and the potential for devastating outcomes should be considered in addition to average numbers when assessing performance.
The size of a potential market crash cannot be determined solely by looking at past crashes, and it is important to prepare for the worst-case scenario. Ergodicity refers to whether the outcome of an activity done many times by one person corresponds to the outcome of the activity done once by many people. Most real-life processes are non-ergodic, meaning that there are too many variables outside of the process itself that can affect outcomes.
Diversification is important to reduce the risk of ruin and increase the chances of ending up comfortable with almost certainty. Strategies for coping with non-ergotic processes include redistribution, which involves reinvesting successful investments elsewhere. Never go all in on a bet, no matter how good it is. The Kelly Criterion suggests betting only a fraction of your wealth depending on the quality of the bet to maximize long-term chances of success.
Overconfidence in all-in decisions can be dangerous and lead to overestimating success. Lessons on uncertainty and probability, such as those taught by a teacher or through games like three card money, are important to learn early on. The barbell strategy involves allocating part of your portfolio to safe investments and a small part to risky bets with high expected returns, minimizing the risk of ruin. This strategy can also apply to career choices and life decisions.
Pursue risky endeavors in a safe and calculated manner to ensure success. Non-ergodicity can lead to positive irreversible consequences, such as learning and creating something lasting. Behavioral change requires intensity and repetition to reach a critical point for lasting results. Consistent repetition of important principles or habits is necessary to ingrain them in people's minds and ensure they are remembered when needed. It is common for people to forget important principles or ideas, even if they seem obvious, which can lead to negative consequences. Getting others to be as focused as you think they ought to be requires relentless reminders and a critical mass of adoption.
Habits are difficult to adopt, but once adopted in one area of life, they become easier to implement elsewhere. Focusing on a single corner or aspect of a company's operations can make it easier to change habits and achieve success. Luca Delana's book "Ergodycity" offers valuable insights on changing habits and can be read quickly for profitable results.