Against the Gods:
The Remarkable Story of Risk

Reviewed by Ronald N. Kahn

Probability and statistics are very recent concepts in human intellectual history.

Starting with this observation, Peter Bernstein advances a provocative argument connecting risk, capitalism, economics, and modern times. Far from mere coincidence, the development of probability and statistics required the atmosphere of the Renaissance, with its questioning of ancient beliefs in perfect worlds and capricious gods.

According to archaeological records, humans have played games of chance since at least 3500 B.C. And yet for most of that time, gamblers have been uninformed of the mathematics of probability.

The ancient Greeks developed powerful ideas of geometry, and viewed the world in terms of "perfect" circles, etc. They also gambled. But in spite of their powerful mathematics, they never understood statistics.¹ Their games of chance provided equal payouts for events not equally likely. For the Greeks, the unpredictable future depended on the whims of many gods. The world view which fostered certain spectacular mathematical advances evidently hindered others.

Games of chance ultimately provided the impetus to develop probability and statistics, but not until the Renaissance, with its very different prevailing world view. In 1494 the Franciscan monk Luca Paccioli posed the question of how to divide the stakes in an uncompleted game. After 150 years, Pascal and Fermat developed mathematical probability theory to answer that question.

In subsequent years, probability theory advanced from a gambler's tool to an instrument for organizing, interpreting, and applying information. This advance started with the Bernoullis, de Moivre, Bayes, and Galton, and has led to our modern quantitative understanding of risk, with contributions from Markowitz, Sharpe, Black, and Scholes, among others.

This argument that the development of probability and statistics required the Renaissance forms half of Bernstein's thesis. The other half argues that the development of the modern economic world required probability and statistics. In particular, modern economic growth requires understanding risk.

What are the expected returns to a new venture? What are the risks? Do the returns outweigh the risks? Can I hedge the risks? In modern economies, the future is not beyond management, not simply subject to the whims of many gods. In fact, the period which marked the development of probability and statistics also marked a time of profound growth in trade, exploration, and wealth. The ideas of risk management enabled the modern economic world, according to Bernstein.

From my perspective as research director at BARRA, too much effusive praise for this book might smack of the self-congratulatory, though it would certainly agree with popular opinion. Last week I saw Against the Gods on a New York Times Bestseller list along with two Dilbert books. So to be fair, the argument has a particular perspective. It ignores other technological inventions (steam engines, electric power, etc.) which also enabled and defined the modern world—similar to those arguments that double-entry bookkeeping has been the most important development in world history. Still, I did find the book original and fascinating, not to mention well-written, and full of the characters and anecdotes we would expect from the author of Capital Ideas and founding editor of the Journal of Portfolio Management. It's a must-read for members of the investment community.

Notes