Against the Gods: The Remarkable Story of Risk / Edition 1

by Peter L. Bernstein

Overview

A Business Week, New York Times Business, and USA Today Bestseller

"Ambitious and readable . . . an engaging introduction to the oddsmakers, whom Bernstein regards as true humanists helping to release mankind from the choke holds of superstition and fatalism."
—The New York Times

"An extraordinarily entertaining and informative book."
—The Wall Street Journal

"A lively panoramic book . . . Against the Gods sets up an ambitious premise and then delivers on it."
—Business Week

"Deserves to be, and surely will be, widely read."
—The Economist

"[A] challenging book, one that may change forever the way people think about the world."
—Worth

"No one else could have written a book of such central importance with so much charm and excitement."
—Robert Heilbroner author, The Worldly Philosophers

"With his wonderful knowledge of the history and current manifestations of risk, Peter Bernstein brings us Against the Gods. Nothing like it will come out of the financial world this year or ever. I speak carefully: no one should miss it."
—John Kenneth Galbraith Professor of Economics Emeritus, Harvard University

In this unique exploration of the role of risk in our society, Peter Bernstein argues that the notion of bringing risk under control is one of the central ideas that distinguishes modern times from the distant past. Against the Gods chronicles the remarkable intellectual adventure that liberated humanity from oracles and soothsayers by means of the powerful tools of risk management that are available to us today.

"An extremely readable history of risk."
—Barron's

"Fascinating . . . this challenging volume will help you understand the uncertainties that every investor must face."
—Money

"A singular achievement."
—Times Literary Supplement

"There's a growing market for savants who can render the recondite intelligibly-witness Stephen Jay Gould (natural history), Oliver Sacks (disease), Richard Dawkins (heredity), James Gleick (physics), Paul Krugman (economics)-and Bernstein would mingle well in their company."
—The Australian

Product Details

ISBN-13:	9780471295631
Publisher:	Wiley
Publication date:	09/14/1998
Pages:	400
Product dimensions:	6.00(w) x 9.00(h) x 1.02(d)

About the Author

PETER L. BERNSTEIN is President of Peter L. Bernstein, Inc., economic consultants to institutional investors. Mr. Bernstein is the author of six books in economics and finance, including the bestselling Capital Ideas: The Improbable Origins of Modern Wall Street, as well as many articles in the professional and popular press. He is the Editor of The Portable MBA in Investment (Wiley) and was the Founding Editor of The Journal of Portfolio Management.

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Table of Contents

Acknowledgments ix

Introduction 1

TO 1200: BEGINNINGS

1. The Winds of the Greeks and the Role
of the Dice 11

2. As Easy as I, II, III 23

1200–1700: A THOUSAND OUTSTANDING FACTS

3. The Renaissance Gambler 39

4. The French Connection 57

5. The Remarkable Notions of the Remarkable Notions Man 73

1700–1900: MEASUREMENT UNLIMITED

6. Considering the Nature of Man 99

7. The Search for Moral Certainty 116

8. The Supreme Law of Unreason 135

9. The Man with the Sprained Brain 152

10. Peapods and Perils 172

11. The Fabric of Felicity 187

1900–1960: CLOUDS OF VAGUENESS AND THE DEMAND FOR PRECISION

12. The Measure of Our Ignorance 197

13. The Radically Distinct Notion 215

14. The Man Who Counted Everything Except Calories 231

15. The Strange Case of the Anonymous Stockbroker 247

DEGREES OF BELIEF:EXPLORING UNCERTAINTY

16. The Failure of Invariance 269

17. The Theory Police 284

18. The Fantastic System of Side Bets 304

19. Awaiting the Wildness 329

Notes 339

Bibliography 353

Name Index 365

Subject Index 369

What People are Saying About This

William Kristol

"A fascinating and unusual perspective on modern man's Promethean attempt to master risk. The book reads easily and provokes thought--a rare combination."—Editor and Publisher, The Weekly Standard

Marc Faber

"In Against the Gods, Peter Bernstein, a scholar, historian, and successful investor gives us the history of great thinkers whose visions put the future at the service of the present."—Managing Director, Marc Faber Limited, Hong Kong

Robert Ferguson

"Peter Bernstein leads us effortlessly through the history of risk because he writes so beautifully. This is a book on a left brain subject that will have right brain readers lining up for more!"—Managing Director, Bankers Trust Australia Limited

Barton M. Biggs

This looks like a new classic to me."—Chairman Morgan Stanley Asset Management, Inc.

John Kenneth Galbraith

"With his wonderful knowledge of the history and current manifestations of risk, Peter Bernstein brings us Against the Gods. Nothing like it will come out of the financial world this year or ever. I speak carefully: no one should miss it."—Professor of Economics Emeritus, Harvard University

Interviews

Exclusive Author Essay
Finance: What Is It, Why Is It, and Where Is It? by Peter L. Bernstein

Finance is a small word, but it covers a huge territory that includes markets, banking, corporate finance, the art of forecasting, accounting, taxation -- and more. In this universe, financial markets are the sun, a dazzling creation around which all the other activities rotate. I set the scene in this short essay, therefore, with some observations about markets before turning to the rest of the subject.

What is that frenzied activity in financial markets all about? Markets are places where buyers and sellers come together to do business; financial markets deal in money and risk. Financial markets are in the first instance a vehicle for financing governments and enterprises that need money. Beyond that, financial markets are a place where owners of outstanding assets can convert those assets into cash, or where owners of cash can find longer-term uses for their money. Financial markets thus give holders of assets with future cash flows the option of realizing the discounted value of those future cash flows in the present. In short, financial markets give investors the opportunity to change their minds, to reverse earlier decisions, at a cost and with a degree of immediacy that direct investment cannot provide. Think of the difference between buying 1,000 shares of IBM for a client and a house for your family.

Reversibility of decisions is the key element in risk. The reversibility provided by financial markets is their most important attribute. Financial markets are a kind of time machine that allows investors to compress the future into the present. Without financial markets, all assets would be buy-and-hold. Financial markets also provide tradable assets that directly hedge risk, by performing the remarkable function -- similar to insurance -- of reducing the holder's dependence on the markets to reverse decisions that might turn out unfavorably. Along the way, financial markets provide divisibility of outstanding issues, which means that investors can reduce risk even further through the invaluable device of diversification.

Through all these methods of reducing the risk of owning assets, financial markets lower the cost of capital and stimulate the spirit of enterprise. Recognizing these features of financial markets is essential to understanding the character of the risks and required returns of nonmarket sources of finance, such as banking, direct investment, and venture capital.

The impact of time on finance is not limited to markets. Time and finance are only opposite sides of the same coin. Finance means that those without cash can obtain cash today instead of waiting until tomorrow or the next day or the next. Thus, time is at the core of all aspects of finance, whether the transaction is in tradable or illiquid assets and whether it involves the sale of newly created financial assets or outstanding issues.

Finance is a service. We cannot touch, smell, or test-drive the next transaction we undertake. As a result, finance cannot operate without trust. Accounting, law, and regulation are indispensable features of a successful financial system. They come first. Finally, because finance is so involved with time, finance is about the future. This means that the study of finance must include techniques of forecasting combined with the valuation of future cash flows. But the future is unknown. So we also require the whole methodology of risk management for those occasions when forecasts turn out to be wrong.

The field is challenging, exciting in its development, and a place to make a fortune -- but also intensely competitive. It is also a fast-moving business: Like many other areas of our economy today, finance seems to be hit by innovation piled on innovation with extraordinary speed. You either keep in step or fall by the wayside. The work of academics and theoreticians in finance is now so closely joined to the efforts of practitioners that continuing education is essential for success.

Studying the literature cannot assure us of getting rich, but ignoring what the experts have to tell us has a high probability of dooming us to failure.

Editorial Reviews

AGAINST THE GODS appeared in the "Washington Is Also Reading..." section of The Washington Post Book World. The book is described as, "A comprehensive history of man's efforts to understand risk and probability, from ancient gamblers in Greece to modern chaos theory."-The Washington Post Book World, September 20, 1998

From the Publisher

The Barnes & Noble Review
What is it that distinguishes the thousands of years of history from what we think of as modern times? This is the question Peter L. Bernstein asks in the beginning of his new book, Against the Gods, and the answer put simply is...risk management.

Risk management? Well, that's not very poetic, is it? But as Bernstein points out, risk is essential to the development of our society; this is as true as the maxim 'nothing ventured, nothing gained' is old. But how did we discover the proper method for calculating insurance premiums in the first place? At what price should a crop future be set so as to be fair to both buyer and seller? It is questions like these that Bernstein, the author of a number of books on economics and finance, answers as he traces the emergence of risk management from calculating the probability of dice games to insuring investment portfolios.

Risk management by definition has to do with 'maximizing the areas where we have some control over the outcome while minimizing the areas where we have absolutely no control over the outcome and linkage between effect and cause is hidden from us.' But at the end of the day, a risk is still a risk no matter how carefully measured, so where does the time-honored 'gut feeling' come into play? This is the central question of Against the Gods, and the answers are enlightening.

We have Blaise Pascal and his probability triangle to thank for the birth of risk management. Pascal solidified the notion that there was a difference between playing games and thinking about playing games. His triangle of numbers is ageometric algebraic equation that can be employed to calculate, for instance, the odds that a team down one game to zero in the World Series has of coming back to win the pennant. (There are 22 combinations of wins and losses out of a possible 64 that the underdog will come back to win, by the way.) The problem with applying such calculations to real-life situations is that pure odds only work if each team has an equal chance of winning.

It wasn't until the Reformation that people began to that understand that they must take responsibility for their own decisions, and as Bernstein duly points out: 'Risk management only becomes possible when people are free agents.' So as awareness of self-determination spread, mathematicians put their minds to methods of determining risk while businessmen put their wallets towards using this information to limit risk.

It was in 1976, however, that one of the most highly developed forms of risk management heretofore imagined was spawned, from the mind of a Berkeley finance professor named Hayne Leland. For a premium, portfolio insurance guarded an investor against incurring huge losses in the stock market. Hayne had devised a scheme that severely limited the downside of the riskiest institution of all! For a time, everything went along gloriously for portfolio insurance, making millions for Leland, until the market crash of October 1987, when such huge losses could not be traded against the income of the premiums paid. At the end of the day, the best risk management failed in the face of the market's oldest precept: You cannot expect to make large profits without taking the risk of large losses. Related work was done by economists Robert C. Merton and Myron S. Scholes: For their mathematical theorems that accurately priced options (thereby drastically reducing the risk factor), they were recently awarded the Nobel Prize in Economics. Their theory is explained in depth in Against the Gods.

I felt a growing sense of anticipation as I read this book, expecting that the progress of risk management would lead me directly to the best investment strategies available. And though the book indeed follows this path, risk management as we know it today stops well short of achieving a foolproof method of playing the market. More to the point, it is human nature that does not allow these measurements to limit risk. "Against the Gods" reads like a good piece of historical fiction in which the events, facts, and dates come alive in the midst of the personalities who effected them. Pascal, for example, renounced mathematics twice in his life, both times turning to religion. With the claim of Renunciation, total and sweet, he gave up high living in favor of the monastery, leaving the unsolved intricacies of managing risks to future generations. And perhaps it is well he did, for it seems that we adhere more to the blind faith, rules of thumb, experience, instinct, and conventions that make up our gut than to the results of risk analysis.—Woodall Taft is a freelance writer who resides near Silicon Valley.

Against The Gods appeared in the "Washington Is Also Reading..." section of The Washington Post Book World. The book is described as, "A comprehensive history of man's efforts to understand risk and probability, from ancient gamblers in Greece to modern chaos theory.

Washington Post Book World

I must say that I enjoyed the book, it was written in a light-hearted manner"

Money Matters

With his wonderful knowledge of the history and current manifestations of risk, Peter Bernstein brings us Against the Gods. Nothing like it will come out of the financial world this year or ever. I speak carefully: no one should miss it..

John Kenneth Galbraith

No one else could have written a book of such central importance with so much charm and excitement.

Robert Heilbronerc

A fascinating and unusual perspective on modern man's Promethean attempt to master risk. The book reads easily and provokes thought—a rare combination.

William Kristol

Peter Bernstein leads us effortlessly through the history of risk because he writes so beautifully. This is a book on a left brain subject that will have right brain readers lining up for more!.

Robert Ferguson

In Against the Gods, Peter Bernstein, a scholar, historian, and successful investor gives us the history of great thinkers whose visions put the future at the service of the present..

Marc Faber

This looks like a new classic to me..

Barton M. Biggs

It's a sizzler!.

Charles P. Kindleberger

Ambitious and readable. . .an engaging introduction to the oddsmakers.

New York Times

An extraordinarily entertaining and informative book.

Wall Street Journal

Risk management, which assumes that future risks can be understood, measured and to some extent predicted, is the focus of this solid, thoroughgoing history. Probability theory, pioneered by 17th-century French mathematicians Blaise Pascal and Pierre de Fermat, has made possible the design of great bridges, electric power utilities and insurance policies. The statistical sampling methods invented by dour Swiss scientist Jacob Bernoulli undergird diverse activities such as the testing of new drugs, stock-picking and wine tasting. Bernstein (Capital Ideas) animates his narrative with a colorful cast of risk-analyzers, including gambling addict Girolamo Cardano, 16th-century Italian physician to the Pope; and John Maynard Keynes, whose concerns over economic uncertainty compelled him to recommend an active, interventionist role for government. Bernstein also traces the development of business forecasting, game theory, insurance and derivatives, and surveys recent advances in risk forecasting made possible through chaos theory and by the development of neural networks.

Publishers Weekly - Publisher's Weekly

For several centuries, mathematics has been the language of the exact sciences. Only in the 20th century has mathematics become predominant in other fields, particularly economics and finance. In this book, Bernstein (Capital Ideas: The Improbable Origins of Modern Wall Street), head of an economic consulting firm, traces the development of probability theory from its beginnings in analyzing games of chance, through its application to statistical theory and insurance, up to its present use in developing investment strategies to control risk. He includes excellent sections on portfolio analysis and on investments in derivatives. Bernstein clearly describes the people, their work, and the events that have revolutionized the thinking on Wall Street. -- Harold D. Shane, Baruch College, City University of New York

Library Journal

An extraordinarily entertaining and informative book.

The Wall Street Journal

Ambitious and readable. . .an engaging introduction to the oddsmakers.

The New York Times