Friday, June 04, 2010

The Probability of Sequential Catastrophic Disasters Hitting the US

Let's hypothetically assume that:
  1. The probability of a catastrophic financial meltdown occurring during a given 5-year period is one in ten thousand (1:10,000); and
  2. The probability of a catastrophic environmental disaster occurring during a given 5-year period is also one in ten thousand (1:10,000).
Given these assumptions, the probability that the occurence of a catastrophic financial meltdown might be immediately followed by an independent catastrophic environmental disaster within the same 5-year period becomes one in one hundred million (1:100,000,000).


Of course, the assumptions above are hypothetical. Nonetheless, the analysis leads me to suspect that the levels of risk assumed by the financial services and energy sectors in recent years have evidently been quite high, and certainly much higher than those portrayed above. Or perhaps recent events in the US are simply one of those one in one hundred million anomalies of fate...

Related Posts:

The Financial Economics of Synthetic Catastrophe

2 comments:

Anonymous said...

Th probability of this particular financial meltdown in that time period was more like 70%. See "The Big Short" by Lewis, and similar.

About the oil rig blowout, we don't yet know most of the circumstances.

So the joint prob could have been >1%

Dr William J McKibbin said...

Hello Anonymous, my point exactly. When you watch the public advertising produced by the financial services and energy sectors, one is left with the distinct impression that these firms are very conservative risk-takers, and that these industries have society's very best interests at heart. However, the reality is that the financial services and energy sectors may very well be assuming gambling level risks of catastrophic loss on a daily basis. The evidence seems to indicate that our nation's largest firms take much greater business and environmental risks than a round of "Texas hold 'em." I have to wonder what frightening risks have been assumed by other industries in America -- I can only imagine. Thanks for your comment...

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