April 22, 2017

“Regression to the mean” is one of the reasons the current risk weighted capital requirements for banks are loony.

Sir, Tim Harford writes: “for statistical reasons, outstanding performances tend to be followed by something less impressive. This is because most performances involve some randomness. On any given day, the worst observed outcomes will be incompetents having an unlucky day and the best observed outcomes will be stars having a lucky day. Observe the same group on another day and, because luck rarely lasts, the former outliers will not be quite as bad, or as good, as at first they seemed. This phenomenon is called “regression to the mean”. “Reversals of fortune have random roots” April 22.

And yet Sir, our dear undercover economist finds it so hard to understand how loony current risk weighted capital requirements for banks really are.

Perhaps he might be interested in what I reflected on when reading Daniel Kahneman’s “Thinking, fast and slow”