How People Make Decisions
What do betting on the underdog winning the Super Bowl, buckling up in the backseat of an Uber, and installing an expensive security system for your rental apartment in a doorman building all have in common?
All of them are decisions you can make that carry both intended and unintended outcomes. But are the likely outcomes of these decisions the same? Not necessarily. Are the motivations behind these decisions the same? Maybe. How about the thought processes behind these decisions? Close. The answer is that they all represent decisions that were made using a risk management framework.
Risk management is nothing new or complex, in fact, all of us actively manage risks everyday. Every decision we make and every action we take inherently carries a certain degree of risk and we all make trade-offs, whether we’re conscious of it or not.
Take for example what you ate for lunch today. Was it a salad? Maybe a slice of meat lovers pizza? Maybe a whole meat lovers pizza? With whichever choice you make, you’re taking on a level of risk (health) for a level of reward (taste).
What is a Risk Management Framework?
There is a risk management framework in place for each of the aforementioned scenarios. But to what effect? Were all three risks equivalent in nature or magnitude? The answer is no.
The level of risk taken should always be at least commensurate with the level of the expected benefit. Furthermore, one’s ability and willingness to take on risk defines the level of their risk tolerance.
What is High Risk Tolerance Behavior?
Sports betting is typically never a prudent risk to take on. The odds are usually stacked against you. However, if you are a risk-seeking individual, it may be suitable for you. A higher risk tolerance individual typically has both the ability to withstand potential losses as well as the willingness to make the bet. Despite fully knowing that a loss might be just as likely as a win.
However, any combination of lower ability or lower willingness would likely lead this gambler to sit on the sidelines this year.
What is Low Risk Tolerance Behavior?
Buying an expensive security system may not be an effective way to fend off burglars in a doorman building. The cost of the system probably outweighs the risk of being burglarized. Yet if you are a very risk-averse person, it may be suitable for you.
This lower risk tolerance behavior could be observed by someone who has a high ability to take on risk considering they live in a doorman building, but a low willingness to trust the system in place, therefore potentially making a “safe” decision with little to no upside.
What Outweighs the Risk Tolerance Scale?
Studies have shown that wearing a seat belt greatly reduces your chance of injury or death in a car accident. In addition, the benefits clearly far outweigh the cost of a minor inconvenience. So in this scenario, it’s all about willingness to take on risk. Ever since manufacturers were legally mandated to provide seatbelts in the 1980s, everyone has had the ability to put on their seat belt when they get in a car.
The willingness, therefore, comes down to self-preservation. In this case, you don’t need to lean towards any particular side of the risk tolerance scale to see the obvious value of buckling up!
How Businesses Make Decisions
Like people, businesses also actively manage all sorts of risks. One could even go as far as defining a business as an organization of people making risk-adjusted decisions to exchange goods or services for some benefit.
The risk-adjusted decision could be your local Thai restaurant offering a new item on the menu. Or maybe it’s Apple deciding to release a larger more expensive iPhone X before releasing less expensive versions. It could even be your employer deciding to hire someone very controversial. In every one of these instances, businesses are making calculated decisions that will inevitably yield both intended and unintended results.
Perhaps the purest representation of risk is the global financial market itself. Quantified by prices, rates and values, risk is simultaneously sought after and feared, it’s essentially the heartbeat of our financial system. The global economy and all of its constituents carry countless risks, and identifying and making sense of as many of them as possible is the job of every financial market participant.
How Does Cadence Handle Risk?
At Cadence, we are hyper focused on assessing risk. As an alternative investment platform bridging private markets with public investors via blockchain technology, we focus on implementing proven risk mitigation strategies, and offer superior risk-adjusted investment opportunities.
While distributed ledger technology unlocks a host of cost efficiencies, our robust internal risk framework is the foundation for every offering. We developed our investment approach with the sole focus of assessing the suitability of every opportunity. We only make investments that pass our rigorous vetting process available to investors.
To mitigate risk, we:
- Painstakingly analyze the creditworthiness of all the counter parties that impact the cash flows that ultimately flow back to our investors
- Utilize a best-practices bottoms-up approach mirroring institutional underwriting standards
- Employ a proprietary risk scorecard to both quantitatively and qualitatively assess every counterparty and offering
- Thoughtfully structure our investment opportunities with the primary objective of protecting your principle
The more data we collect and track from each successful investment offering, the more predictive our risk framework will become. This will ultimately enable us to offer more unique opportunities to you, our investors.
Ready to buckle up?