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Making decisions
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6.5 The social construction of quantifiable risk

Earlier in this course we referred to the way in which social groups can develop shared cognitive schema. One important role for shared cognitive schema is to define the risks that we pay attention to, the dread in which we hold them and the perceived likelihood of their occurrence. Because these perceptions affect behaviour, they also play a role in selecting the risks that we face. In the last half century, some sociologists suggest (e.g. Beck, 1992; Giddens, 1990) that our concerns with risk have shifted largely from what nature does to us to what we do to nature. Rather than being concerned with natural risks we are increasingly concerned with manufactured risks. Unlike natural risks, the risks that we manufacture are affected by how we perceive them. For example, consider the following apparent paradox. Road traffic in the UK increased twenty-fivefold between 1922 and 1986, and common perceptions of the dangers of roads changed from roads as relatively safe places to roads as dangerous places. Yet over the same period the number of children killed in road traffic accidents fell from 736 per annum to 358. The child road-death figure per motor vehicle fell by about 98 per cent (Adams, 1995, p.11). The ‘objective’ measure of road safety is in contrast to perceptions of roads as unsafe. Why might this be? As social perceptions of road risk have changed, so too has our behaviour. Parents no longer allow their children to play in the road and they teach them to exercise greater vigilance when crossing the road. The risks we construct as a society are changed by our beliefs about them.

To take another example, a series of railway accidents in the UK led to great public concern about the risk of rail travel. One consequence has been a shift in the industry of resources and effort from ensuring a reliable and timely service to ensuring an accident-free service. As a result, there has been a shift among previous rail passengers to greater car use, with implications for greater risk of road accidents. One way of understanding this at a social level is not as a process of risk avoidance but as process of risk selection: as a society we select the risks we face.

This reflexive nature of risk is also apparent in the field of finance: for instance, the risks of investing in particular markets are significantly affected by aggregate investor perceptions of the risks of such investment. Market panics can lead to very rapid price swings multiplying the risks faced by investors. To give another finance example, an important element in the downfall of the Long Term Capital Management (LTCM) hedge fund was the change in the perceptions of risks associated with assets held by LTCM as a consequence of changes in other investors' interpretations of LTCM's behaviour. LTCM held a large highly diversified portfolio of assets and had made very significant returns from arbitrage activities related to those assets. (Arbitrage is the process of buying and selling assets and securities to benefit from pricing anomalies and thus make a profit.)

An important part of their risk-management strategy was to invest in assets with uncorrelated returns so that a fall in value of one asset would not be matched by changes in value of others. However, the success of LTCM had created a fan club. Fans of LTCM tried to emulate their success by building up matching portfolios of assets. When a market crisis was triggered by the Russian default on their sovereign debt, LTCM needed to offload assets. However, the values of different assets in their diverse portfolio had become linked by virtue of the same assets being held by many investors. As they tried to sell assets, prices plummeted as their fan club also started to sell. The subsequent collapse of this fund came close to destabilising financial markets and triggering a series of bank failures around the world.