Against the Gods: The Remarkable Story of Risk

by Peter L. Bernstein

Even more important, he propounded the idea that the satisfaction resulting from any small increase in wealth “will be inversely proportionate to the quantity of goods previously possessed.” With that innocent-sounding assertion, Bernoulli explained why King Midas was an unhappy man, why people tend to be risk-averse, and why prices must fall if customers are to be persuaded to buy more. Bernoulli’s statement stood as the dominant paradigm of rational behavior for the next 250 years and laid the groundwork for modern principles of investment management. Almost exactly one hundred years after the collaboration between Pascal and Fermat, a dissident English minister named Thomas Bayes made a striking advance in statistics by demonstrating how to make better-informed decisions by mathematically blending new information into old information. Bayes’s theorem focuses on the frequent occasions when we have sound intuitive judgments about the probability of some event and want to understand how to alter those judgments as actual events unfold.