what is risk?

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skeptic88
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what is risk?

Post by skeptic88 » Sat Sep 27, 2014 7:15 pm

I understand that bogleheads are not necessarily in complete agreement with the efficient market hypothesis, however, I believe it is safe to say that we for the most part, accept it.
However, I am having a hard time understanding why volatility is considered the determining factor of risk. Almost all proponents of indexing discuss volatility of the underlying factor in risk
i.e stocks have higher returns than bonds but are much more volatile.

But if a stock in ones portfolio goes bankrupt, then you have permanently lost money and its safe to say that the stock will not be volatile anymore.
Can someone help me understand this?

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celia
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Re: what is risk?

Post by celia » Sat Sep 27, 2014 7:29 pm

I see risk and volatility as two separate concepts.

The US dollar is the safest currency there is, yet it is volatile when compared to other currencies.

Risk is the chance you take for something that may or may not happen in the future and how likely it is to happen. In general, the more risk you take, the bigger the rewards (or loss).
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Re: what is risk?

Post by HoosierJim » Sat Sep 27, 2014 7:41 pm

One way to look at the risk/volatility is to imagine you have to price and sell options on stocks. Let's say 2 stocks - John Deere and Catepillar sell for $90 / share but Catepillar swings $10 per day up or down while Catepillar stays right at $90 each day. Further assume that both stock tend to track together with the ups and downs of the farm/construction industry.

If you had to sell an option to allow a buyer to purchase 100 shares on 1/1/2015 (about 90 days away), which one would you charge more money for? The difference in price you would charge is the imply volatility risk premium.

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Re: what is risk?

Post by nisiprius » Sat Sep 27, 2014 7:58 pm

"Risk" has numerous definitions... which are often manipulated for rhetorical purposes.

The reasons why "risk" is often equated with volatility is that this is the way it is used as a technical term in financial economics.

It is similar to the word "power" which can mean social dominance, or military might, but in physics is used to mean force times distance per unit of time.

The meaning of the word "risk" in financial economics is probably influenced by Frank Knight's 1921 book, Risk, Uncertainty, and Profit. Wikipedia's article says that
In that book, he carefully distinguished between economic risk and uncertainty. Situations with risk were those where the outcomes were unknown but governed by probability distributions known at the outset. He argued that these situations, where decision making rules such as maximising expected utility can be applied, differ in a deep way from "uncertain" ones, in which not only the outcomes, but even the probability models that governed them, were unknown.
This, in turn, leads to the use of standard deviation as a measure of "risk."

It is easy to complain that this isn't what the word "risk" means to us, but it is a useful concept, it needs to have a name, "risk" is as good as any, and "risk" happens to be the one that is used. One might as well complain that not every horse is capable of working at a rate of one horsepower. That's true, but it isn't a good reason to change the definition of "horsepower."
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Re: what is risk?

Post by pkcrafter » Sat Sep 27, 2014 8:02 pm

skeptic88 wrote:I understand that bogleheads are not necessarily in complete agreement with the efficient market hypothesis, however, I believe it is safe to say that we for the most part, accept it.
However, I am having a hard time understanding why volatility is considered the determining factor of risk. Almost all proponents of indexing discuss volatility of the underlying factor in risk
i.e stocks have higher returns than bonds but are much more volatile.

But if a stock in ones portfolio goes bankrupt, then you have permanently lost money and its safe to say that the stock will not be volatile anymore.
Can someone help me understand this?

I think you are pretty perceptive. Volatility is a standard measure and it's useful for portfolio construction, but a lot of Bogleheads do not believe it to define risk. I think this is a much better definition: Risk is the chance that the money you have saved for something won't be there when you need it.

I attempted to address this recently in an article posted on the Bogleheads Blog -- Perceptions On Investing – Risk, 3rd in the Series

http://www.bogleheads.org/blog/perceptions-on-investing-risk-3rd-in-the-series/#more-1362

Howard Marks of Oaktree Capital has done some good work on risk.

http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0CCAQFjAA&url=http%3A%2F%2Fwww.oaktreecapital.com%2FMemoTree%2FRisk%2520Revisited.pdf&ei=bVonVL7jCYKLoQSZ44CIDw&usg=AFQjCNG5lxPi6x1SFENUzPjnVJnHJu6p7w&bvm=bv.76247554,d.cGU


Paul
Last edited by pkcrafter on Sat Sep 27, 2014 10:14 pm, edited 1 time in total.
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Re: what is risk?

Post by rkhusky » Sat Sep 27, 2014 8:19 pm

Standard deviation is used as a proxy for risk because it easy to use mathematically.

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JoMoney
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Re: what is risk?

Post by JoMoney » Sat Sep 27, 2014 8:20 pm

Volatility is a type of risk, but it gets way over used as a proxy assuming it measures all sorts of risk. It's handy because past volatility can be measured perfectly in hind-sight, and math geeks who like to pretend the market is some sort of casino game can use it to form sciencey looking charts and tables, regardless of what bearing the past volatility has toward any future prospects.
People don't like uncertainty, and are prone to using tools that would purport to give them some idea of precision. Unfortunately, that just brings in new risks when people starting believing those tools offer precision that they don't. Some people believe that because volatility gets equated to risk, that an asset that is more volatile has a higher "expected return" and think that adding more volatility raises the probability of earning higher returns, whereas they may simply be adding higher variability and adding equal or even greater likelihood of earning lower returns. Even if the market is pricing "risk premiums", things like the "low-volatility anomaly" should suggest that past volatility is not the risk the market is concerned with.
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Re: what is risk?

Post by richard » Sat Sep 27, 2014 8:20 pm

When Harry Markowitz developed Modern Portfolio Theory in the 1950s, he needed a way to quantify risk. This was before modern digital computers, so he needed a means of quantifying risk that was easy to compute. Volatility met those criteria.

Since then, volatility has survived due to inertia and ease of explanation in textbooks and presentations by financial advisors.

A better way to define risk is the chance you won't have enough money when you need it. Alas, this is not an easy concept to quantify, so those who believe running calculations is the key to investing stick to things they can use in formulas. Without formulas, how can we draw pretty charts?

As an aside, Markowitz noted that his theories were no longer modern by the end of the 1950s, but the term has stuck, as it sounds good. http://en.wikipedia.org/wiki/Modern_por ... ry#History

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Re: what is risk?

Post by bobcat2 » Sat Sep 27, 2014 8:24 pm

I fail to understand why so many posters at Bogleheads have so much trouble understanding the common definition of risk in finance and economics. This isn't hard guys. :oops:

Here risk is defined in several leading economics and finance textbooks.

Risk is uncertainty that "matters" because it affects people's welfare.
Merton et al - Financial Economics

The term risk refers to the variability of the outcomes of some uncertain activity.
Nicholson - Microeconomic Theory

Risk is the uncertainty associated with the end-of-period value of an investment in either a single asset or a portfolio of assets.
Sharpe et al - Investments

Risk - the variability (or unpredictability) an asset contributes to a saver's real wealth.
Krugman et al - International Economics

The presence of risk means that more than one outcome is possible.
Bodie et al - Investments

Three of these definitions come from Nobel prize winners and two of the Nobel winners (Sharpe and Merton) won for their work in financial economics. Another definition comes from Bodie et al - Investments, the world's best selling MBA level textbook on investments.


Here is the definition of risk from SBBI - the investment bible.

Risk - The extent to which an investment is subject to uncertainty. Risk may be measured by standard deviation.
SBBI 2005 edition

Notice that all the above definitions of risk say roughly the same thing using different words. What is difficult to understand about this?

Pick one of the above. They are all saying essentially the same thing. How bout the one from William Sharpe.

Risk is the uncertainty associated with the end-of-period value of an investment in either a single asset or a portfolio of assets.

What is it that you find unclear in this definition of risk?

In what material way is the above Sharpe definition of risk different from the SBBI definition?

The extent to which an investment is subject to uncertainty.




Or for that matter any of the other four definitions of risk I quoted?

Notice that SBBI also correctly brings volatility into the discussion. Volatility, or standard deviation, is one of the most used methods in finance of measuring risk. It is not a definition of risk; it is rather a way of measuring risk.

Your blood glucose level is not the definition of diabetes, but instead one way to measure whether you have diabetes or not. It is the same with volatility in finance. It is not a definition of risk, but rather one way to measure financial risk.

BobK

PS - My signature is yet another way of saying the common definition of risk in finance and economics. :happy
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Re: what is risk?

Post by bobcat2 » Sat Sep 27, 2014 8:34 pm

The meaning of the word "risk" in financial economics is probably influenced by Frank Knight's 1921 book, Risk, Uncertainty, and Profit.
NO NO NO !!!

Frank Knight distinguished uncertainty from risk. Knight died over 40 years ago. You are referring to a book that Knight wrote about a 100 years that was delayed in being published until after WWI.

The economics profession, including financial economists, rejected Knightian risk and Knightian uncertainty a very long time ago. This is yet another situation where a huge gap has developed between economists on the one hand and investment professionals and investment enthusiasts on the other.

By the late 1940s Knight's approach to risk had been replaced by the expected utility approach to risk pioneered by von Neumann and Morganstern. The modern definition of risk in economics follows from the risk foundation developed by von Neumann and Morganstern, not from the much earlier work by Knight.

Knight did make a lasting contribution to economics in this vein however. Knight was the first to truly stress that many economic decisions are made when we are not certain of the outcomes. Before that nearly all of economics was concerned with situations where the outcome was known with certainty.

We can see how Knight unintentionally has affected modern finance by how Robert Merton defines finance.
-
Finance is the study of how to allocate scarce resources over time under conditions of uncertainty.


Now Robert Merton is using the modern definition of uncertainty in his definition of finance, but Merton's definition stresses that finance is not about deterministic outcomes.

I say that Knight unintentionally had a huge impact on finance because Knight's work on risk and uncertainty was concerned by decisions made by government officials and business managers and the effects of those decisions on the overall economy. None of Knight's work on risk and uncertainty dealt with financial assets.

A practical problem with Knightian risk is that if we take it literally risk refers to very little other than games of chance. Nearly everything important in finance and economics would fall under the heading of uncertainty under a literal interpretation of Knightian risk and uncertainty. I guess we could use definitions of common uncertainty vs. black swan uncertainty to further subdivide uncertainty. :)

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Re: what is risk?

Post by richard » Sat Sep 27, 2014 8:47 pm

Sharpe has said risk is the probability of doing badly in bad times.

Which comes closer to your idea of risk: your portfolio doing badly in bad times (not having money when you need it) or not being certain what your portfolio will be worth at some point in the future?

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Re: what is risk?

Post by AviN » Sat Sep 27, 2014 8:50 pm

The rational investor in economic models wants to maximize expected return while minimizing the expected standard deviation of that return. Unfortunately, the expected return of a company that is no longer in business is 0%.

skeptic88 wrote:But if a stock in ones portfolio goes bankrupt, then you have permanently lost money and its safe to say that the stock will not be volatile anymore.
Can someone help me understand this?

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Re: what is risk?

Post by bobcat2 » Sat Sep 27, 2014 9:21 pm

richard wrote:Sharpe has said risk is the probability of doing badly in bad times.

Which comes closer to your idea of risk: your portfolio doing badly in bad times (not having money when you need it) or not being certain what your portfolio will be worth at some point in the future?
There is a difference between a particular risk and the definition of risk. A nasty risk would be a portfolio performing poorly in bad times. Such particular risks are bad news, but they are not the definition of risk.

There are lots of nasty risks. I could live longer than my portfolio. That's a risk that I hope not to face, but it is not the definition of risk. Instead it's a particular financial risk known as longevity risk.

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In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Re: what is risk?

Post by telemark » Sat Sep 27, 2014 9:37 pm

Volatility is a simple way of modeling risk. Like all models, it can be useful as long as you understand its limitations. In practice there are many different kinds of risk; for example, bonds are subject to default risk, interest rate risk, inflation risk, etc. and these may show up at different times.

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Re: what is risk?

Post by pkcrafter » Sat Sep 27, 2014 10:06 pm

Bobcat wrote:
I fail to understand why so many posters at Bogleheads have so much trouble understanding the common definition of risk in finance and economics. This isn't hard guys. :oops:

Bobcat, the common academic definitions, which you are using, fail to connect with average investors. This is at the center of the risk definition problem.

Here risk is defined in several leading economics and finance textbooks.

Risk is uncertainty that "matters" because it affects people's welfare.
Merton et al - Financial Economics

The term risk refers to the variability of the outcomes of some uncertain activity.
Nicholson - Microeconomic Theory

Risk is the uncertainty associated with the end-of-period value of an investment in either a single asset or a portfolio of assets.
Sharpe et al - Investments

Risk - the variability (or unpredictability) an asset contributes to a saver's real wealth.
Krugman et al - International Economics

The presence of risk means that more than one outcome is possible.
Bodie et al - Investments

Three of these definitions come from Nobel prize winners and two of the Nobel winners (Sharpe and Merton) won for their work in financial economics. Another definition comes from Bodie et al - Investments, the world's best selling MBA level textbook on investments.

Here is the definition of risk from SBBI - the investment bible.

Risk - The extent to which an investment is subject to uncertainty. Risk may be measured by standard deviation.
SBBI 2005 edition

Notice that all the above definitions of risk say roughly the same thing using different words. What is difficult to understand about this?

Not difficult to understand--they are all the very similar and they don't resonate with average investors.
:wink:

Nisiprius
The meaning of the word "risk" in financial economics is probably influenced by Frank Knight's 1921 book, Risk, Uncertainty, and Profit
.

Bobcat:
NO NO NO !!!

Frank Knight distinguished uncertainty from risk.


I think Nisiprius made that clear:
In that book, he carefully distinguished between economic risk and uncertainty. Situations with risk were those where the outcomes were unknown but governed by probability distributions known at the outset. He argued that these situations, where decision making rules such as maximizing expected utility can be applied, differ in a deep way from "uncertain" ones, in which not only the outcomes, but even the probability models that governed them, were unknown.

Bobcat, you continue to refer to economic risk as defined by the academics, and certainly you are correct, but average investors don't connect well with it. Uncertainty is much more visual and troublesome to investors. In fact, I would have to say that uncertainty defines risk much better simply because it's not quantifiable. For instance, how much of your invested assets can you lose in the market?

So, I'll modify my definition of risk: Risk is the uncertainty that the money you have saved for something will actually be there when you need it.

Yeah, heresy, I know. :(

I still think you are Bobcat #1


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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Re: what is risk?

Post by telemark » Sat Sep 27, 2014 10:07 pm

Yet another type of risk is opportunity cost, the money you don't make while waiting for something that may never happen. This one is easy to overlook because the financial press never runs scary stories about it. You can never eliminate all forms of risk, just decide which ones apply to your situation and work to minimize those.

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Re: what is risk?

Post by CyberBob » Sun Sep 28, 2014 12:37 am

    The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.

    Investments that are denominated in a given currency, like bonds, are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.

    I believe that over any extended period of time investment in productive assets, whether businesses, farms, or real estate will prove to be the runaway winning category. More important, it will be by far the safest.

Excerpt from Warren Buffett's 2011 letter to Berkshire Hathaway shareholders

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Re: what is risk?

Post by Rodc » Sun Sep 28, 2014 2:32 am

[OT post removed by admin LadyGeek]


No need to be insulting.

I used to have some similar ideas, but later came to realize that academics don't own definitions and that while highly specific definitions have an important place in rigorous science (which frankly may leave out economics) being overly pedantic often makes ivory tower types not very useful in the real world. That is what we see here. A definition in rigorous science is good if it leads to being able to formulate testable hypotheses or provable theorems. But if the results are not useful then I suppose the only point is being able to publish papers to trade with other academics.

I think it is clear that the current academic definition, while considered locked down like it was handed down from God by some, would better serve real people with continued thoughtfulness and refinement.

Feel free to insult me as well if you like, though I suspect it won't reflect much on me.
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Re: what is risk?

Post by richard » Sun Sep 28, 2014 7:44 am

Which is riskier:

1) Certain to miss your goal by a large margin.

2) May miss your goal by a large margin, may exceed your goal by a large margin.

Under Bob's definition, 2 is riskier - it has more "Uncertainty of outcomes". I find it hard to believe anyone would prefer 1. If so, does that mean everyone would prefer more risk to less risk?

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Re: what is risk?

Post by tadamsmar » Sun Sep 28, 2014 7:58 am

pkcrafter wrote:I think this is a much better definition: Risk is the chance that the money you have saved for something won't be there when you need it.


I think the better definition is: Risk is the chance you will not have the money you need.

Under your definition, it's not risk if you all the money you saved is available and I don't think that captures all the risk that should be of concern to those saving and investing for retirement.

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Re: what is risk?

Post by packer16 » Sun Sep 28, 2014 8:32 am

This is an interesting question. I think Howard Marks has the best explanation of the "hidden" aspect of risk. He also describes the diversity of the definition of risk. For some it is the risk of not obtaining a real return (those in the accumulation phase). For others it is more tied to volatility as they are in the distribution phase. For still others in the accumulation phase it may be tied to volatility if they don't stay the course due to volatility. To say there is one definition of risk is an oversimplification of reality and limits the applicability of the solutions derived thereof.

His (via Elroy Dimson) definition of risk is what you get when the outcome is not what you expected. Risk cannot be predicted a-priori and can only be observed in the past. You can develop an educated guess about what risk may be in the future but it is dependent upon what appears to be random factors. I think you can with more certainty estimate relative asset class returns that will result from risk than absolute returns.

An example is the financial crisis. The risk of the crisis before it happened was there but not perceived by many. The volatility of stocks had been low and declining for a few years then the realization that many mortgage securities purchased where not going to be paid back and the tipping point was reached. Leverage magnified the effect. The reaction of banking authorities and other controllers of leverage can influence this by either magnifying the risk or dampening it. Letting Lehman go BK magnified it but saving others reduced risk. If you study the Crash of 1929 you get the same factors. The big difference in 1929 is the leverage authorities made it worse rather than better by there actions. We have at least gotten smarter over time.

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Re: what is risk?

Post by George-J » Sun Sep 28, 2014 9:20 am

skeptic88 wrote:I understand that bogleheads are not necessarily in complete agreement with the efficient market hypothesis, however, I believe it is safe to say that we for the most part, accept it.
However, I am having a hard time understanding why volatility is considered the determining factor of risk. Almost all proponents of indexing discuss volatility of the underlying factor in risk
i.e stocks have higher returns than bonds but are much more volatile.

But if a stock in ones portfolio goes bankrupt, then you have permanently lost money and its safe to say that the stock will not be volatile anymore.
Can someone help me understand this?

My suggestion with a smile ( :happy ) - spend at least 10 years thinking about what "risk" means (or of the word "love" - another 4 letter word) - I'm on my second decade or more. :beer

In the meantime read Howard Mark's recent s "Risk Revisited"

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Re: what is risk?

Post by 555 » Sun Sep 28, 2014 10:03 am

skeptic88 wrote:But if a stock in ones portfolio goes bankrupt, then you have permanently lost money and its safe to say that the stock will not be volatile anymore.
Can someone help me understand this?

Before it happens, it is not certain, and even after it happens, it's not the only thing in your portfolio, so either way there is still uncertainty.

It's true that if it were 100% certain that your entire portfolio would go to zero and stay there, then yes, "risk" would be zero. But you could probably find something better to invest in.

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Re: what is risk?

Post by bobcat2 » Sun Sep 28, 2014 10:19 am

richard wrote:Which is riskier:

1) Certain to miss your goal by a large margin.

2) May miss your goal by a large margin, may exceed your goal by a large margin.

Under Bob's definition, 2 is riskier - it has more "Uncertainty of outcomes". I find it hard to believe anyone would prefer 1. If so, does that mean everyone would prefer more risk to less risk?


Definition of risk

Before defining risk we need to define the related term uncertainty.

Uncertainty simply means that we are not certain what will happen in the future.
or
Uncertainty means more than one outcome is possible.

The standard definition of risk in finance and economics is straightforward.

Risk is uncertainty that affects people’s welfare.

Thus, investment risk is uncertainty that matters with regard to returns.

Here is another way of expressing the definition of risk in finance and economics.

A risky situation is a nontrivial situation where more than one outcome is possible.

Sometimes, particularly when discussing financial asset risk, we divide the uncertainty (risk) of the returns into two parts. The upside uncertainty is called opportunity or upside risk, and the downside uncertainty is called risk or downside risk.

Finally, the definition of risk in finance and economics is neither a specific risk, nor is it a measure of risk.


The above is not my definition. It is the standard definition. Alas, I don't have my own definitions of words or terms in finance, a subdivision of economics. I am stuck with the standard definitions people in the field of finance use and accept. Those awaiting BobK's personal definitions of financial words and terms wait in vain. :(

If something is certain to happen there is no uncertainty or risk. Many bad outcomes are certain, but they are not risky. They are simply bad. If I jump from an airplane without a parachute flying at 30,000 feet I will certainly die, but I am not taking a risk. I am dying with certainty. People who jumped from the upper floors of the World Trade center on 9/11 weren't taking on a risk of dying, they simply preferred that way of dying to burning to death.

If I want to have $70,000 per year in real income in retirement but my annual rate of planned savings, number of years I plan to work, and my conservative investments will only result in income of $55,000 to $60,000 at most, I am not at risk of missing my goal. I am going to miss my goal with near certainty. That is an outcome that I am not pleased with, but one which I have decided to accept because I am unwilling to save more, work longer, or invest a higher proportion of my portfolio in risky assets and run the chance or risk of an uncertain outcome that could be even lower.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Re: what is risk?

Post by richard » Sun Sep 28, 2014 10:29 am

bobcat2 wrote:<snip>If I want to have $70,000 per year in real income in retirement but my annual rate of planned savings, number of years I plan to work, and my conservative investments will only result in income of $55,000 to $60,000 at most, I am not at risk of missing my goal. I am going to miss my goal with near certainty. That is an outcome that I am not pleased with, but one which I have decided to accept because I am unwilling to save more, work longer, or invest a higher proportion of my portfolio in risky assets and run the chance or risk of an uncertain outcome that could be even lower.<>

It is circular to claim risk is uncertainty, then to say the certainty of being in a risky situation (not having enough money) is not risky because it's not uncertain.

The academic definition of risk you've chosen to highlight does not correspond to normal usage, which is better reflected in the dictionary definition, "a situation involving exposure to danger".

I'm with Rodc, tadamsmar and pkcrafter (and any similar).

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Re: what is risk?

Post by Doc » Sun Sep 28, 2014 10:44 am

richard wrote:It is circular to claim risk is uncertainty, then to say the certainty of being in a risky situation (not having enough money) is not risky because it's not uncertain.


Richard I think you are changing Bob's definition.

Bob is calling risk the non-zero probability of an uncertain outcome.

You are calling risk the non-zero probability of a "bad" uncertain outcome.

As investors we are often most concerned with that "bad" outcome so much so the uncertain "good" outcome in finance is often ignored. You have to include both the good and the bad in the definition because somebody else is on the other side of any trade and what is bad for you is good for him. Being risky to one side and certain on the other side of a trade is not logical. (See Spock.) Your "exposure to danger" shows the emphasis on one side of the trade.
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Re: what is risk?

Post by bobcat2 » Sun Sep 28, 2014 11:04 am

Risk is uncertainty that matters to peoples welfare. If you and I flip a coin a 100 times at a penny a flip, there is uncertainty in the outcome but there is no risk. The financial uncertainty is trivial. If, OTOH, we flip the same coin a 100 times at $5,000 a flip, that uncertain outcome is risky. Being in a bad situation that is certain is wretched, but there is no risk involved. Someone on his deathbed dying from terminal pancreatic cancer is in a bad situation where death is inevitable in a short period time. He is not, however, facing a risk of dying from cancer.

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Re: what is risk?

Post by bertilak » Sun Sep 28, 2014 11:12 am

richard wrote:Which is riskier:

1) Certain to miss your goal by a large margin.

2) May miss your goal by a large margin, may exceed your goal by a large margin.

Under Bob's definition, 2 is riskier - it has more "Uncertainty of outcomes". I find it hard to believe anyone would prefer 1. If so, does that mean everyone would prefer more risk to less risk?

I say number 2 is riskier.

Number one is not risky at all. It is certain. When we are dealing with certainties there is no need to factor in risk. Being certain to fail is a problem but it is not a risk problem so methods of dealing with risk are beside the point as are all the subtleties of defining, understanding, mitigating and even getting compensated for risk.

Trying to make risk analysis encompass number 1 just muddies the waters.

At least that's how it looks to me.

EDIT: I see that bobcat2 makes the same point using terminal cancer as an example. If you don't think it is the same point then I haven't made myself clear.
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Re: what is risk?

Post by bobcat2 » Sun Sep 28, 2014 11:28 am

Merriam-Webster dictionary definition of risk (noun) -
-the possibility that something bad or unpleasant (such as an injury or a loss) will happen

- someone or something that may cause something bad or unpleasant to happen
- a person or thing that someone judges to be a good or bad choice for insurance, a loan, etc.

Full Definition of RISK
1) possibility of loss or injury : peril

2) someone or something that creates or suggests a hazard

3) (a) the chance of loss or the perils to the subject matter of an insurance contract; also : the degree of probability of such loss
(b) a person or thing that is a specified hazard to an insurer
(c) an insurance hazard from a specified cause or source <war risk>

4) the chance that an investment (as a stock or commodity) will lose value



Definition of risk (verb)

- to put (something) in a situation in which it could be lost, damaged, etc.

- to do something that could result in (something bad or unpleasant)

- to do (something that may have harmful or bad results)


In economics and finance, an allowance for the hazard (risk) in an investment or loan. Default risk refers to the chance that a borrower will not repay a loan. If a banker believes that a borrower may not repay a loan, the banker will charge the true interest plus a premium for the default risk, the premium depending on the degree of presumed risk. All stock investment carries an implicit risk since there is no guarantee of return on investment. Trading or variability risk is the amount that the return may vary, up or down, from the expected return on investment.


Link to Merriam-Webster definition of risk - http://www.merriam-webster.com/dictionary/risk

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Re: what is risk?

Post by LadyGeek » Sun Sep 28, 2014 11:40 am

skeptic88 wrote:I understand that bogleheads are not necessarily in complete agreement with the efficient market hypothesis, however, I believe it is safe to say that we for the most part, accept it.
However, I am having a hard time understanding why volatility is considered the determining factor of risk. Almost all proponents of indexing discuss volatility of the underlying factor in risk
i.e stocks have higher returns than bonds but are much more volatile.

But if a stock in ones portfolio goes bankrupt, then you have permanently lost money and its safe to say that the stock will not be volatile anymore.
Can someone help me understand this?

I think there's another point besides arguing on definitions; that being what's know as the "sequence of returns." Over the long term, i.e. getting from Point A to Point B will generally make money.

However, there are a lot of zigs and zags to get there. The sequence of returns says that you will need your money precisely at a time when the stock market tanks.

Volatility is the amount the market (or a stock) zigs and zags. You want to minimize this amount so your exposure to bottoming out at the worst possible time is minimized.

You can do that by indexing and minimizing your chances of loss by taking comfort in large numbers (index funds which hold a lot of stocks), or diversify with different asset classes (bonds). In either case, the idea is to keep things on a smooth and steady course.

There is no free lunch, so you will sacrifice the return of your investment for the safety of getting to your goals. See the wiki: Risk and return: an introduction
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Re: what is risk?

Post by bertilak » Sun Sep 28, 2014 11:50 am

LadyGeek wrote:However, there are a lot of zigs and zags to get there. The sequence of returns says that you will need your money precisely at a time when the stock market tanks.

Volatility is the amount the market (or a stock) zigs and zags. You want to minimize this amount so your exposure to bottoming out at the worst possible time is minimized.

I like seeing those two concepts (sequence of returns, volatility) linked together like that.
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Re: what is risk?

Post by stlutz » Sun Sep 28, 2014 12:38 pm

A few thoughts on the OP's original question

"Risk" is itself a qualitative concept and what risks matter vary from person to person. As has been discussed, for someone in the distribution phase, "sequence of returns" is a very real risk; for someone who is 25 y.o., this is not much of a risk.

Standard deviation is a common numerical measure of risk. That is not the same thing as saying that standard deviation = risk. A investment that is highly volatile is more likely to have all sorts of risks (plural) associated with it. The number is simply an indication that this is the case.

With portfolio construction, things do go awry when there is an excessive focus on historical theoretical portfolio standard deviation. Some try to put a bunch of highly volatile (risky) investments together, note that the risks balanced out over a cherry-picked historical time period, and viola, the portfolio is now non-risky. That is simply not the case. Spreading your risks around can be a good thing, but on the other hand, all of the risks can show up at the same time.

A good example of this is pairing stocks with long-term bonds. No question this pairing reduced volatility (risk?) in 2008-9. However, the risks are still there, and it certainly can happen that stocks and long-term bonds would go down in a significant way at the same time. The fact that both stocks and LT bonds have high standard deviations should clue you into the fact that there are both "risky" investments and that pairing them together will yield a "risky" portfolio.

The other thing an investor should watch for is when she experiences a particular risk to a greater extent than other market participants. Again, to use LT nominal bonds, there are a large number of market participants for whom these are basically risk-free assets (i.e. insurance companies)--their obligations are long-term and they are nominal. For individuals, obligations can be unpredictable and they are impacted by inflation. As such, LT bonds are not generally a worthwhile risk for individual investors to take as the risks they are experiencing are not fully priced in.

Conversely, when you experience risk to a lesser extent than other participants--those are worthwhile risks to take. Over the long haul, global stocks almost always outperform bonds, and when they lose, they lose by a small amount. For someone with a long investing horizon, having a significant allocation to stocks becomes a worthwhile risk to take.

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Re: what is risk?

Post by 555 » Sun Sep 28, 2014 1:14 pm

555 wrote:
skeptic88 wrote:But if a stock in ones portfolio goes bankrupt, then you have permanently lost money and its safe to say that the stock will not be volatile anymore.
Can someone help me understand this?

Before it happens, it is not certain, and even after it happens, it's not the only thing in your portfolio, so either way there is still uncertainty.

It's true that if it were 100% certain that your entire portfolio would go to zero and stay there, then yes, "risk" would be zero. But you could probably find something better to invest in.


OP, does this answer your question? Mostly this thread has gone off on a tangent about semantics. I couldn't see anyone addressing the actual question.

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Re: what is risk?

Post by pkcrafter » Sun Sep 28, 2014 2:21 pm

Bobk, first, I took no offense at your Humpty Dumpty comparison. One thing we all need to do is understand why there are such long and emotional discussions every time risk is brought up. This isn't trivial, it has to do with how we should define risk. We have to try and find a way that is actually useful to investors. It is pretty obvious by the number of investors who bail out in market crashes and by investor returns vs fund returns that investors don't have a good sense of risk.

Now let's look at what I said that pushed your button--

Risk is the uncertainty that the money you have saved for something will actually be there when you need it.


I think it was the use of the word uncertainty that you objected to, but what about a few of the "correct" definitions you used. If not uncertainty you object to, maybe it's magnitude of how much an investor's shortfall might be.

Risk is uncertainty that "matters" because it affects people's welfare.
Merton et al - Financial Economics

Risk is the uncertainty associated with the end-of-period value of an investment in either a single asset or a portfolio of assets.
Sharpe et al - Investments


I don't see how my definition is much different than Merton's or Sharpe's. I don't have any objection to your academic definitions, but I do question the usefulness to the average investor.

Some alternative thinking...

http://glynholton.com/wp-content/uploads/2006/10/risk.pdf

It is not the purpose of this article to propose a strategy for assessing risk and recommending investments as a result of that assessment. Nor is its purpose to address the components associated with risk and how those components can be impacted by investment work. That is a job for behavioral finance. What I do hope to accomplish is to further motivate a dialogue for investment professionals to open their thinking to other ideas of assessing risk and to question, (in the words of Ken Fisher), "What is it that I believe that is wrong?" Maybe one of those beliefs is that SD defines investment risk.
Patrick Chitwood


http://www.fa-mag.com/news/article-1726.html


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Re: what is risk?

Post by backpacker » Sun Sep 28, 2014 2:52 pm

I don't know why it matters how academics define risk. If they have the wrong definition of risk, they're just wrong and we should tell them that. It's not like economics is a science like physics or chemistry.

Von Neumann and Morganstern gave us modern expected utility theory. But we shouldn't use their "authority" to batter posters who have different views about risk. This is because their treatment of risk is insane. I value $1000 ten times as much as $100. So Von Neumann and Morganstern tell me that I'm irrational unless I am indifferent between a 10% chance at a $1000 and having $100 for sure. But that's nuts. So expected utility theory doesn't tell us how investors should think about risk.

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Re: what is risk?

Post by Rodc » Sun Sep 28, 2014 4:12 pm

skeptic88 wrote:I understand that bogleheads are not necessarily in complete agreement with the efficient market hypothesis, however, I believe it is safe to say that we for the most part, accept it.
However, I am having a hard time understanding why volatility is considered the determining factor of risk. Almost all proponents of indexing discuss volatility of the underlying factor in risk
i.e stocks have higher returns than bonds but are much more volatile.

But if a stock in ones portfolio goes bankrupt, then you have permanently lost money and its safe to say that the stock will not be volatile anymore.
Can someone help me understand this?


Once you have lost all your money there is no more risk - you have hit bottom. :)

The general problem for an academic, a salesman of investments, or an author is they need generic risk definitions and generic measures that are widely applicable even if not very good in specific situations. Different risks will effect different people differently, but it is far too complex to have hundreds, or even tens, of different measures for different situations.

Volatility, and more over the usual measure of volatility, standard deviation, is a fair approximation to what if often risk for many people (for example if the market is down and you need to sell because you have lost your job). It certainly is not the only measure. One can look at what the worst N-year return looks like if one has a longer outlook. One can look at home often stocks fail to at least return X%. One can look at the worst draw-down over N-years if you are spending money out of a portfolio. Rather than nit pick definitions, just consider some plausible scenarios that would harm your financial situation - those are risky situations you want to understand. I have looked at some of these and was surprised how well any measure I came up with correlated with standard deviation. That is, if portfolio A was higher in some risk measure I computed than portfolio B, then the standard deviation of was higher than for B. I was surprised.

So standard deviation is a widely used measure because it is generic and so is widely applicable if not really on target for every person or situation, it is easy to understand, easy to compute, easy to manipulate.

But at best it is half of what many want to know. To understand the distribution of even something as simple as the Normal distribution you need MEAN and STD. Standard deviation leaves out a ton of information you need to understand the likelihood of reaching your goals, how likely and how large a shortfall you may face.

I would also note a seeming widely used measure here is likelihood of running out of money if use some fixed withdrawal rate. Running out of money is of course a real risk for many retirees. This measure has its problems too, for example it models an income strategy that is not really a practical, but still has it value. But it is not as simple or easy to use as std.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: what is risk?

Post by bobcat2 » Sun Sep 28, 2014 4:51 pm

Paul,

You are unbelievable. You write the following.
I don't have any objection to your academic definitions, but I do question the usefulness to the average investor.

Some alternative thinking...

http://glynholton.com/wp-content/upload ... 0/risk.pdf


If we go to the above article on your supposed "alternative thinking" on risk, what is the definition of risk Glyn Holton gives. It is exactly the same common definition of risk that I have been using. It is not some other alternative definition of risk. Here is where he defines risk in the paper.
I now attempt to define risk. In this article, I am not interested in some aspect of risk or some category of risk. I am
seeking a general definition. To this end, consider some situations that involve risk:
•trading natural gas,
•launching a new business,
•military adventures,
•asking for a pay raise,
•sky diving, and
•romance.

Any general definition must encompass all of these. The situations may appear disparate, but they share certain common elements. First, people care about the outcomes. If someone has a personal interest in what transpires, that person is exposed. Second, people don’t know what will happen. In each situation, the outcome is uncertain. It seems that risk entails two essential components:
•exposure and
uncertainty.

Risk, then, is exposure to a proposition of which one is uncertain.

Suppose a man leaps from an airplane without a parachute. If he is certain to die, he faces no risk. Risk requires both exposure
and uncertainty.


Risk and uncertainty are the same thing according to Holton, if the uncertainty affects someones welfare, which is the common definition of risk I have been using.

Holton even uses the same example I used about there being bad situations where no risk is involved. Namely the example of jumping out of a plane without a parachute.

How can one possibly conclude that there is any significant difference in the following two definitions of risk :?: :!:

Risk is exposure to a proposition of which one is uncertain.
-Glyn Holton

Risk is uncertainty that "matters" because it affects people's welfare.
Merton et al - Financial Economics

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Re: what is risk?

Post by cfs » Sun Sep 28, 2014 5:22 pm

In the way I see it.

Keeping it simple. Risk (from Investopedia): The chance that an investment's actual return will be different than expected.
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Re: what is risk?

Post by backpacker » Sun Sep 28, 2014 5:26 pm

bobcat2 wrote:How can one possibly conclude that there is any significant difference in the following two definitions of risk :?: :!:

Risk is exposure to a proposition of which one is uncertain.
-Glyn Holton

Risk is uncertainty that "matters" because it affects people's welfare.
Merton et al - Financial Economics


You might not have read through the whole article. Holton say the above definition " clarifies common usage" and "offers insights" but is "flawed." He thinks finance should use notions of risk that are operationalized. Our common notion of risk can't be operationalized, so isn't satisfactory for doing finance. Holton then endorses pragmatism. The right notions of risk to be using in finance is whatever operationalized notions (like SD) we find useful.

I don't agree with Holton. But he clearly has a different perspective. Thanks Paul for posting this!
Last edited by backpacker on Sun Sep 28, 2014 6:38 pm, edited 1 time in total.

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Re: what is risk?

Post by 555 » Sun Sep 28, 2014 6:13 pm

backpacker wrote:Von Neumann and Morganstern gave us modern expected utility theory. But we shouldn't use their "authority" to batter posters who have different views about risk. This is because their treatment of risk is insane. I value $1000 ten times as much as $100. So Von Neumann and Morganstern tell me that I'm irrational unless I am indifferent between a 10% chance at a $1000 and having $100 for sure. But that's nuts. So expected utility theory doesn't tell us how investors should think about risk.

Ridiculous! It's completely obvious that you totally made that up.

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Re: what is risk?

Post by backpacker » Sun Sep 28, 2014 6:33 pm

^ I know! It's nuts. My example is just the Allais paradox. For the truth, see this paper. :beer

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Re: what is risk?

Post by Pizzasteve510 » Sun Sep 28, 2014 7:11 pm

backpacker wrote:
bobcat2 wrote:How can one possibly conclude that there is any significant difference in the following two definitions of risk :?: :!:

Risk is exposure to a proposition of which one is uncertain.
-Glyn Holton

Risk is uncertainty that "matters" because it affects people's welfare.
Merton et al - Financial Economics


You might not have read through the whole article. Holton say the above definition " clarifies common usage" and "offers insights" but is "flawed." He thinks finance should use notions of risk that are operationalized. Our common notion of risk can't be operationalized, so isn't satisfactory for doing finance. Holton then endorses pragmatism. The right notions of risk to be using in finance is whatever operationalized notions (like SD) we find useful.

I don't agree with Holton. But he clearly has a different perspective. Thanks Paul for posting this!


I like this definition, because I see a lot of posts here describing outcomes without discussion of the underlying root causes. In my experience, Money is made and lost by people. Behavior 'in the trenches' by executives and employees are formed as they act on instructions, gut feelings, information, physical circumstances and policy.

In a former life I helped design methodologies for and led several Enterprise Risk Assessment engagements and among the many risks we discussed were included: strategic, operational, legal, financial, technology, and reputation risks (among many others). Any of these can tank performance, or alternatively lead to breakthrough opportunities if managed better than competitors. We explored the likelihood, magnitude of impact and mitigation strategies one might act on. In the end, risk management can't overwhelm the efforts of running and delivering value to customers, so it is a very complex topic. Financial risk related to profits are only one dimension of enterprise risk.

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Re: what is risk?

Post by richard » Sun Sep 28, 2014 7:12 pm

bertilak wrote:
richard wrote:Which is riskier:

1) Certain to miss your goal by a large margin.

2) May miss your goal by a large margin, may exceed your goal by a large margin.

Under Bob's definition, 2 is riskier - it has more "Uncertainty of outcomes". I find it hard to believe anyone would prefer 1. If so, does that mean everyone would prefer more risk to less risk?

I say number 2 is riskier.

Number one is not risky at all. It is certain. When we are dealing with certainties there is no need to factor in risk. Being certain to fail is a problem but it is not a risk problem so methods of dealing with risk are beside the point as are all the subtleties of defining, understanding, mitigating and even getting compensated for risk.

Trying to make risk analysis encompass number 1 just muddies the waters.

At least that's how it looks to me.

EDIT: I see that bobcat2 makes the same point using terminal cancer as an example. If you don't think it is the same point then I haven't made myself clear.

It appears most people are risk adverse - they prefer less risk to more. Do you seriously believe there is any rational person who would prefer 1 to 2, let alone most people?

Why would including something with no risk compared to something with risk muddy the waters? The idea is to illustrate the point very clearly and starkly.

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Re: what is risk?

Post by SDBoggled » Sun Sep 28, 2014 7:27 pm

Just wanted to thank CyberBob for the Buffet quote, pkcrafter for the Oakmark doc and skeptic88 for the original post.

As an engineer pretty comfortable with standard deviation, I never felt that SD worked well as a measure for my interest in risk. Since I am a not yet retired, buy and hold, never sell low investor, the volatility of small caps is not of great concern, so long as over 20+ years they don't provide a lower return.

However, I can appreciate that it is a very important measure for many investors... illustrated by the outflow from stock funds during financial crisis.

The Buffet quote and Oakmark doc, gave me some language to describe my pro real estate - anti-bond bias :-) I hope to be rewarded for risks of illiquidity, leverage and concentration. I manage my financing and interest risk with fixed rate mortgages and am susceptible to all other risks... particularly management(me) risk with not knowing what I don't know :-(

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Re: what is risk?

Post by bertilak » Sun Sep 28, 2014 7:35 pm

richard wrote:
bertilak wrote:
richard wrote:Which is riskier:

1) Certain to miss your goal by a large margin.

2) May miss your goal by a large margin, may exceed your goal by a large margin.

Under Bob's definition, 2 is riskier - it has more "Uncertainty of outcomes". I find it hard to believe anyone would prefer 1. If so, does that mean everyone would prefer more risk to less risk?

I say number 2 is riskier.

Number one is not risky at all. It is certain. When we are dealing with certainties there is no need to factor in risk. Being certain to fail is a problem but it is not a risk problem so methods of dealing with risk are beside the point as are all the subtleties of defining, understanding, mitigating and even getting compensated for risk.

Trying to make risk analysis encompass number 1 just muddies the waters.

At least that's how it looks to me.

EDIT: I see that bobcat2 makes the same point using terminal cancer as an example. If you don't think it is the same point then I haven't made myself clear.

It appears most people are risk adverse - they prefer less risk to more. Do you seriously believe there is any rational person who would prefer 1 to 2, let alone most people?

You miss the point. There are lots of bad things in this world. Risk isn't the only one and it isn't at the top of the list. Some risks might not even be on the list. Some might be seen as "the spice of life." Gambling is a good example.
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Re: what is risk?

Post by pkcrafter » Sun Sep 28, 2014 7:54 pm

backpacker wrote:
bobcat2 wrote:How can one possibly conclude that there is any significant difference in the following two definitions of risk :?: :!:

Risk is exposure to a proposition of which one is uncertain.
-Glyn Holton

Risk is uncertainty that "matters" because it affects people's welfare.
Merton et al - Financial Economics


You might not have read through the whole article. Holton say the above definition " clarifies common usage" and "offers insights" but is "flawed."

Thank you for pointing that out.

Paul


He thinks finance should use notions of risk that are operationalized. Our common notion of risk can't be operationalized, so isn't satisfactory for doing finance. Holton then endorses pragmatism. The right notions of risk to be using in finance is whatever operationalized notions (like SD) we find useful.

I don't agree with Holton. But he clearly has a different perspective. Thanks Paul for posting this!
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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Re: what is risk?

Post by 555 » Sun Sep 28, 2014 7:57 pm

backpacker wrote:Von Neumann and Morganstern gave us modern expected utility theory. But we shouldn't use their "authority" to batter posters who have different views about risk. This is because their treatment of risk is insane. I value $1000 ten times as much as $100. So Von Neumann and Morganstern tell me that I'm irrational unless I am indifferent between a 10% chance at a $1000 and having $100 for sure. But that's nuts. So expected utility theory doesn't tell us how investors should think about risk.
555 wrote:Ridiculous! It's completely obvious that you totally made that up.
backpacker wrote:^ I know! It's nuts. My example is just the Allais paradox. For the truth, see this paper. :beer

Okay, that's interesting, but your example is not an instance of Allais paradox.

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Re: what is risk?

Post by pkcrafter » Sun Sep 28, 2014 8:19 pm

Pizzasteve510 wrote:
backpacker wrote:
bobcat2 wrote:How can one possibly conclude that there is any significant difference in the following two definitions of risk :?: :!:

Risk is exposure to a proposition of which one is uncertain.
-Glyn Holton

Risk is uncertainty that "matters" because it affects people's welfare.
Merton et al - Financial Economics


You might not have read through the whole article. Holton say the above definition " clarifies common usage" and "offers insights" but is "flawed." He thinks finance should use notions of risk that are operationalized. Our common notion of risk can't be operationalized, so isn't satisfactory for doing finance. Holton then endorses pragmatism. The right notions of risk to be using in finance is whatever operationalized notions (like SD) we find useful.

I don't agree with Holton. But he clearly has a different perspective. Thanks Paul for posting this!


I like this definition, because I see a lot of posts here describing outcomes without discussion of the underlying root causes. In my experience, Money is made and lost by people. Behavior 'in the trenches' by executives and employees are formed as they act on instructions, gut feelings, information, physical circumstances and policy.

I think you've identified the key to why we can't agree on how to define risk in a way everyone can relate to, and also the main area (behavior) that needs to be somehow included in discussions. I suspect it's emotional make-up that causes the many different views on what risk is and what it means to investors with different levels of loss aversion.

Paul




In a former life I helped design methodologies for and led several Enterprise Risk Assessment engagements and among the many risks we discussed were included: strategic, operational, legal, financial, technology, and reputation risks (among many others). Any of these can tank performance, or alternatively lead to breakthrough opportunities if managed better than competitors. We explored the likelihood, magnitude of impact and mitigation strategies one might act on. In the end, risk management can't overwhelm the efforts of running and delivering value to customers, so it is a very complex topic. Financial risk related to profits are only one dimension of enterprise risk.
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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Re: what is risk?

Post by richard » Sun Sep 28, 2014 8:49 pm

bertilak wrote:
richard wrote:
bertilak wrote:
richard wrote:Which is riskier:

1) Certain to miss your goal by a large margin.

2) May miss your goal by a large margin, may exceed your goal by a large margin.

Under Bob's definition, 2 is riskier - it has more "Uncertainty of outcomes". I find it hard to believe anyone would prefer 1. If so, does that mean everyone would prefer more risk to less risk?

I say number 2 is riskier.

Number one is not risky at all. It is certain. When we are dealing with certainties there is no need to factor in risk. Being certain to fail is a problem but it is not a risk problem so methods of dealing with risk are beside the point as are all the subtleties of defining, understanding, mitigating and even getting compensated for risk.

Trying to make risk analysis encompass number 1 just muddies the waters.

At least that's how it looks to me.

EDIT: I see that bobcat2 makes the same point using terminal cancer as an example. If you don't think it is the same point then I haven't made myself clear.

It appears most people are risk adverse - they prefer less risk to more. Do you seriously believe there is any rational person who would prefer 1 to 2, let alone most people?

You miss the point. There are lots of bad things in this world. Risk isn't the only one and it isn't at the top of the list. Some risks might not even be on the list. Some might be seen as "the spice of life." Gambling is a good example.

Sure, but we're not discussing bad things in general, we're discussing the definition of risk.

Looking at two portfolios and determining which is riskier seems precisely on point. Any definition of risk which suggests 2 is riskier than 1 seems to miss the point.

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bertilak
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Re: what is risk?

Post by bertilak » Sun Sep 28, 2014 10:51 pm

richard wrote:
bertilak wrote:
richard wrote:It appears most people are risk adverse - they prefer less risk to more. Do you seriously believe there is any rational person who would prefer 1 to 2, let alone most people?

You miss the point. There are lots of bad things in this world. Risk isn't the only one and it isn't at the top of the list. Some risks might not even be on the list. Some might be seen as "the spice of life." Gambling is a good example.

Sure, but we're not discussing bad things in general, we're discussing the definition of risk.

Looking at two portfolios and determining which is riskier seems precisely on point. Any definition of risk which suggests 2 is riskier than 1 seems to miss the point.

Well, you're the one that said something was risky because it was bad (see underline). I disagree with that. Risk isn't the only thing that determines preference.
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