Sam Savage And His War Against Averages – Creating A New Data Type For Risky Models
using single numbers in spreadsheets used to model financial risk and instead use a “distribution” – a range of numbers. He says that by using a distribution or “dist” we would be able to not only produce better models of uncertainty but we would avoid fundamental mistakes in modeling financial and operational performance.
Mr Savage recently published a book “The Flaw of Averages – Why we underestimate risk in the face of uncertainty” which explains his evangelism for the use of dists within financial models of risk.
Currently, the most widely used method of predicting uncertainty is to use single numbers, usually representing a single average of expected outcomes.
However, models based on average assumptions are wrong on average. This is a paradox that has been known by mathematicians for nearly 100 years, called Jensen’s Inequality. Although business schools teach Jensen’s Inequality, business managers continue to use average numbers to try to model things like demand, production, and project completion time. And they are constantly surprised by real world outcomes that can be very costly.
