Risk is like
quantum mechanics:
If you think you understand Risk, you don't understand Risk
Maggid after : Feynman
If you are not completely confused by Risk, you do not understand it
Maggid after : John Wheeler
Sure, risk is hard to tackle. The more you learn about risk, the more you become aware of it's sneaky characteristics (clustering, tails, etc).
This is why becoming a qualified actuary takes an incredible amount of time, hard study and many years of experience. As masters in Risk, actuaries understand the limits in modeling and calculating Risk.
Murphy
Probably one of the more intriguing risk quotes is :
"Anything that can go wrong, will go wrong"
by the famous Edwin Murphy.
A quote that keeps an actuary mind busy.... After all, as actuaries it is our duty to quantify and explain uncertainty (as much as is possible) in board rooms and on the accounting table. Not only when decisions have to be taken, but also after things turned out wrong or different from what we thought. This is - to put it mildly - no 'easy task' and it's not getting easier in the near future.....
Just like Murphy, actuaries experienced last decades that (statistic) bad luck often collaborates with bad timing. What drives God (i.e. quantum mechanics or 'Murphy probability') to confront us - (poor) actuaries - with 'fair value volatility', 'longevity explosions', 'subprime defeats', 'imploding real estate market's and 'extraordinary solvency demands by supervisors', all at the same time time?
(Un)Luckily, help is on the way.... In 2004 British Gas commissioned some scientists to create a formula to predict Murphy's Law, also known as
Sod's Law.
Murphy's Formula
In a 2005 study, based on a survey of 1,023 adults, Murphy’s Law was shown 'statistically significant'. The final report also supplied a formula for predicting occurrences of Murphy’s Law. Here it is....
Let U, C, I, S, and F be integers between 1 and 9, reflecting respectively comparative levels of Urgency, Complexity, Importance, Skills, and Frequency in a given set of circumstances. Let A, which stands for Aggravation, equal 0.7 (Please, don’t ask why). The likelihood (L) of Murphy’s Law obtaining under those circumstances, on a scale of 0 to 8.6, turns out to be:
L = [((U + C + I) x (10 - S)) / 20] x A x 1 / (1 - sin (F / 10))
Murphy's Formula strikes itself
Unfortunately, Murphy's law suffered from self reference, as one of the authors, the mathematician Phil Obayda, commented on a 2004 blog that this
formula is wrong.
The correct formula according to Phil is:
P= (((U+C+I) * (1-S))/2) * A * (1/(1-Sin F))
with P = probability of Sod's Law Occuring and U, C, I, S and F values greater than 0 and less than 1, keeping the mysterious A = 0.7.
Murphy's formula simplified
Simplifying this last formula leads to Maggid's formula for the probability (%) of Murphy hitting you, whenever you perform a task:
Although application of this formula is not (yet) an obligated part of the actuary's
Code of Professional Conduct, please check this equation anytime you're about to defend an actuarial advice on a Board's table.
How to use Murphy's formula: an Actuarial Example
Let's do a simple exercise to demonstrate the power of Murphy's formula:
You've developed a risk model of the Stock market. In a meeting the Chair of the board asks you how certain you are of your model being right. You know the
difference between risk and uncertainty, so you say
"one moment please" and pick up your pocket calculator while reflecting:
This is a ´U=3, I=9,C=10,F=3´ situation, and I'm a S=9 actuary. That calculates as P=10.4% of Murphy hitting me. Within 20 seconds you (over)confidently answer: I`m about 90% sure of my model!
The Chair of the Board looks desperate... His eyes reflect: ´Is 90% good or bad?` You didn't realize your model was that important to the board. But.. if that's so, 'Importance' should not be rated at I=9 but at I=10, raising the failure probability to almost 11%. Now you start doubting yourself : What if you overestimated yourself? What if you're only a AA-Actuary (level S=7) instead of a AAA (level S=9)? This would increase the probability of failing to 31.3%. Suddenly you realize you're only one step away from a major personal actuarial meltdown.
You get yourself together, regain your self confidence, realize you're one of the best actuaries in the world (S=10) and full of confidence you reply the questioning eyes of the Chair with: "Sir, I'm almost 100% certain my model is right.
The Board is relieved and content. You're an actuary they can trust. Now they can decide without hesitation.
So next time you want to know the failure probability of a task, use the next Online Murphy Calculater.
Good Luck with Murphy's calculator!
Used sources/Links:
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Sod’s Law: A Proof
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Newyorker: Murphy At the Bat
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The Engineering of Murphy's Law?
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Legend, Inc. Murphy's Laws
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The Stock Market: Risk vs. Uncertainty
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Murphy's Online Calculator
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