Saturday, March 07, 2009

March Madness and Risk Management Strategy

Every vice, if it hangs around long enough, starts attracting self-justifying quotes. Ben Franklin came up with one of my favorites: “Beer is proof that God loves us and wants us to be happy.” I don’t necessarily agree, but I can empathize with anyone looking for ways to reduce their own cognitive dissonance. I also have a vice that I find virtuous: "March Madness," the annual NCAA college basketball tournament.

Each year, along with about 2 million other people, I sign up for Yahoo’s College Basketball Tournament Pick’em to see how many I can get right. Personal obsessions and Izzomania aside, I will proclaim with all sincerity that the skills you need to consistently make good picks in the NCAA tournament will also make you better at security risk management. Both risk management and tournament bracketology are based on making risk choices under uncertainty; both involve the judicious use of outside experts, rich statistical data, and intangibles. They also share the trait that over the short term, it’s really tough to tell the difference between luck and skill.

March Madness 101
The single elimination tournament is played in six rounds, with 64 teams seeded in 4 regions. In the first round, teams are paired with the highest seed playing the lowest seed e.g. 1 plays number 16, 2 goes against 15, all the way down to 8 against the 9th seeded team. Winners advance, so assuming that the high seed wins each game, in the second round the number one seed would then play the number eight team in the region; the two seed will play number seven, etc. Of course, the high-seed teams are regularly upset by lower seeds with a randomness and regularity that is … maddening.

Points are awarded during each round for correct picks as follows:

RoundPoints per correct pickNumber of gamesPossible points
113232 points
221632 points
3 ("Sweet 16")4832 points
4 ("Elite 8")8432 points
5 ("Final Four")16232 points
6 (National Championship)32132 points
Maximum Possible192 points

So there are 63 decisions to take before the first game begins, and the goal is to predict the winner of each game, in each round, in such a way as to maximize your total score:

Score for the round = points available * number of correct picks

This equation bears a very strong resemblance to the standard information risk equation below, which is used to calculate loss expectancy as part of the risk assessment process. Both equations define a payoff as the product of something you know quite a bit about (impact) and something that you can estimate to some level of confidence but not perfectly predict:

Risk exposure = risk impact * event probability

So if you get pushback for following the tournament in minute detail, obsessing over your picks and constantly checking your rankings every time there’s an update, take heart: It's not just a tournament, it’s a huge learning opportunity. Decision making in a dynamic, competitive situation with limited information and lots of uncertainty is a great environment for building your risk optimization skills.

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