Peter L. Bernstein
Against the Gods
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.”
“Fascinating.. this challenging volume will help you understand the uncertainties that every investor must face.”
“A singular achievement.”
“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.”
Copyright © 1996, 1998 by Peter L. Bernstein. All rights reserved. Published by John Wiley & Sons, Inc.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, (978) 750–8400, fax (978) 750–4744. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 605 Third Avenue, New York, NY 10158-0012, (212) 850-6011, fax (212) 850-6008, E-Mail: [email protected].
This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering professional services. If professional advice or other expert assistance is required, the services of a competent professional person should be sought.
Library of Congress Cataloging-in-Publication Data :
Bernstein, Peter L.
Against the gods: The remarkable story of risk/Peter L. Bernstein.
p. cm.
Includes bibliographical references and index.
ISBN 0-471-29563-9 (paper)
1. Risk Management. 2. Decision-making. 1. Title.
HD61.B4666 1996
368 – dc20
96–33861
Acknowledgments
The suggestion that I write a book about risk came from the late Erwin Glickes, then president of The Free Press. Erwin was a man who projected copious amounts of power, persuasiveness, and charm. Although he considered my long experience as a professional investor to be sufficient qualification for the task he had in mind, I soon discovered, as I had feared, that risk does not begin and end on the floor of the New York Stock Exchange.
The vastness of the subject matter is daunting. Risk touches on the most profound aspects of psychology, mathematics, statistics, and history. The literature is monumental, and each day’s headlines bring many new items of interest. Consequently, I have had to be selective. I believe, however, that the omission of any important material was the result of a decision on my part rather than an act of oversight.
For this project, I have been far more dependent on other people than I had been in my earlier forays into writing books. Old friends as well as many complete strangers from a wide variety of disciplines have provided invaluable assistance combined with criticisms and creative suggestions. In this case, increasing the number of cooks was a clear benefit. My gratitude to them is boundless. There would have been no book at all without them.
Convention dictates that expressions of appreciation to spouses and editors should come at the end of the list of acknowledgments, but on this occasion I choose to mention my wife and my editor first. That is where they belong.
Barbara, my wife as well as my business partner, provided countless creative ideas, conceptual contributions, and positive criticisms, all of them essential to the task; there is barely a page that does not reflect her influence. In addition, her success in arranging our lives to accommodate this whole project made all the difference between progress and chaos.
Myles Thompson of John Wiley has been critically important to the project. I have been privileged to have his expert editorial suggestions, to enjoy his enthusiastic leadership, and to benefit from his professional management. Myles’s colleagues at Wiley have cooperated with me in every way possible from start to finish. Everett Sims’s copy-editing helped me to make sense where there was confusion, while his masterful use of the scalpel exorcised a great deal of fluff in the manuscript without harm to the content below.
A few people rendered assistance far beyond the call of duty. I owe a special debt to Peter Dougherty for his countless inestimable comments and suggestions. Mark Kritzman was a tireless pilot through the shoals of mathematical and statistical treatments. Richard Rogalski and his associates at the Baker Library at Dartmouth saved me untold hours by making their facilities available to me at long distance; Rich’s good humor and eagerness to help added to the joy of having his generous assistance. Martin Leibowitz bestowed a gift of immensely valuable material that has enriched the content of the book. Richard and Edith Sylla were indefatigable investigators at points where the going was the roughest. Stanley Kogelman furnished me with a priceless tutorial in probability analysis. Leora Klapper served as an ideal research assistant: indefatigable, enthusiastic, thorough, and prompt.
Molly Baker, Peter Brodsky, Robert Ferguson, Richard Geist, and William Lee were good enough to read segments of early versions of the manuscript. They gave me the running start I needed in order to transform rough drafts into a finished material.
The following people also made significant contributions to my work and warrant my deepest appreciation: Kenneth Arrow, Gilbert Bassett, William Baumol, Zalmon Bernstein, Doris Bullard, Paul Davidson, Donald Dewey, David Durand, Barbara Fotinatos, James Fraser, Greg Hayt, Roger Hertog, Victor Howe, Bertrand Jacquillat, Daniel Kahneman, Mary Kentouris, Mario Laserna, Dean LeBaron, Michelle Lee, Harry Markowitz, Morton Meyers, James Norris, Todd Petzel, Paul Samuelson, Robert Shiller, Charles Smithson, Robert Solow, Meir Statman, Marta Steele, Richard Thaler, James Tinsley, Frank Trainer, Amos Tversky,1 and Marina von N. Whitman.
Eight people generously undertook to read the manuscript in its entirety and to give me the benefit of their expert criticisms and suggestions. Each of them, in his own way, deserves major credit for the quality of the content and style of the book, without bearing any responsibility for the shortcomings it contains. Here they are: Theodore Aronson, Peter Brodsky, Jay Eliasberg, Robert Heilbroner, Peter Kinder, Charles Kindleberger, Mark Kritzman, and Stephen Stigler.
I end with a note of thanks to my late parents, Allen M. Bernstein and Irma L. Davis, who inspired much of the enthusiasm that went into the creation of this book.
Peter L. Bernstein
Introduction
What is it that distinguishes the thousands of years of history from what we think of as modern times? The answer goes way beyond the progress of science, technology, capitalism, and democracy.
The distant past was studded with brilliant scientists, mathematicians, inventors, technologists, and political philosophers. Hundreds of years before the birth of Christ, the skies had been mapped, the great library of Alexandria