Illusion of Control

A challenge to the conventional wisdom surrounding financial risk, providing insight into why easy solutions to control the financial system are doomed to fail   Finance plays a key role in the prosperity of the modern world, but it also brings grave dangers. We seek to manage those threats with a vast array of sophisticated mathematical tools and techniques of financial risk management. Too often, though, we fail to address the greatest risk—the peril posed by our own behavior.   Jón Daníelsson argues that critical risk is generated from within, through the interactions of individuals and perpetuated by their beliefs, objectives, abilities, and prejudices. He asserts that the widespread belief that risk originates outside the financial system frustrates our ability to measure and manage it, and the likely consequences of new regulations will help alleviate small-scale risks but, perversely, encourage excessive risk taking. Daníelsson uses lessons from past and recent crises to show that diversity is the best way to safeguard our financial system.

“In The Illusion of Control, [Daníelsson] argues that putting central banks in charge of financial stability is an error because they face ‘a complex, ill-defined policy domain for which there is no clear consensus on either the problem or the objective.’ So, the enterprise is doomed to fail. Separate agencies, with more direct political accountability, are needed for that task.”—Sir Howard Davies, The Guardian“In this thought-provoking book, Jón Daníelsson, professor of finance at the London School of Economics, offers five recommendations. First, ‘the real danger is endogenous risk,’ that is, the risks the system itself creates. Second, models of risk will always miss what matters. Third, remember the objectives of regulation. Fourth, think globally, not locally. Finally, encourage a diverse financial system, not a monoculture.”—Martin Wolf, Financial Times, “Best Books of 2022: Economics”“Daníelsson dives into why financial crises happen. His explanations also lay waste to conventional thinking.”—Mike Berner, The Tycoonist“Jón Daníelsson provides a fascinating synthesis of systemic financial crises, based on theoretical and empirical research.”—George Inderst, IPE“Too little financial regulation or too much of the wrong kind? Whatever your view, Jón Daníelsson’s lively account and richly informed discussion will surely intrigue you and challenge preconceptions.”—Patrick Honohan, former governor, Central Bank of Ireland“Financial regulators should be required to read this book. It shows in sparkling and non-technical language what aspects of risk can, and frequently cannot, be measured. Anyone concerned with portfolio management should read it.”—Charles Goodhart, London School of Economics“Jón Daníelsson makes a compelling case for a fundamental re-think in the approach to risk management taken by both financial services firms and their regulators. Those charged with the management, governance and regulation of risk—either at the level of an entity or an economy—should benefit enormously from Jón ’s alternative framework.”—Lutfey Siddiqi, Risk Management Institute, National University of Singapore“Is international cooperation on regulatory standards stifling good risk taking, leading to bad risk taking? Refreshingly critical, The Illusion of Control is an important contribution to the ongoing mapping of financial risk.”—Yves Mersch, former ECB board member and vice-chair, Single Supervisory Mechanism

Jón Daníelsson is a professor of finance and the director of the Systemic Risk Centre at the London School of Economics. He is the author of Financial Risk Forecasting and Global Financial Systems: Stability and Risk.