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Friday, June 13, 2008

"Panglossian" world financial system

Paul Krugman had compared the modern day investment manager, who sees only the silver lining in every dark cloud and ignores risk from rational considerations, to Voltaire's hero Pangloss.

Daniel Cohen feels that this Panglossian investment manager "realises that the downside is limited to being fired, but the upside is limitless. This asymmetry between profits and losses encourages audacity. Once a certain risk threshold is breached, the investment manager who places bets with other people’s money ignores danger. From a social point of view, the problem stems from the divergence of incentives. Even though the intermediary knows that he may suffer a severe personal loss, it will never be proportional to the losses inflicted on investors".

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