The Flaw of Averages: Why We Underestimate Risk in the Face of Uncertainty

Preface

The Flaw of Averages describes a set of common avoidable mistakes in assessing risk in the face of uncertainty. It helps explain why conventional methods of gauging the future are so wrong so often, and is an accessory to the recent economic catastrophe. Once grasped, these ideas can lead recent us to more effective forecasting and decision making. Traditionally, these topics have been the domain of probability and statistics. Although I will assume no prior knowledge of these subjects, for those who have had formal training in these subjects, it should take only a few chapters to repair the damage.

My perspective no doubt derives largely from my father, Leonard Jimmie Savage. Although well below average on academic scales during his early education, he emerged as a prominent mathematical statistician who collaborated closely with Milton Friedman, among others. One of their students was the founder of modern portfolio theory, Harry Markowitz, who claims that my father “indoctrinated him at point blank range with rational expectation theory.” Thus I am a child of the University of Chicago School of Economics.

Early on it was clear I possessed at least one of my father’s traits. I, too, was a below-average student, displaying neither athletic nor academic aptitude. The defining moment of my high school education came in an after-class conference with my English teacher in my junior year at the University of Chicago Laboratory School. She explained that I was failing the ...