In the first few weeks of 2022, we have had repeated reminders from the market that risk never goes away for good, even in the most buoyant markets, and that when it returns, investors still seem to be surprised that it is there. Investors all talk about risk, but there seems to be little consensus on what it is, how it should be measured, and how it plays out in the short and long term. In this post, I will start with a working definition of riskt that we can get some degree of agreement about, and then look at multiple measures of risk, both at the company and country level. In closing, I will talk about some of the more dangerous delusions that undercut good risk taking.
What is risk?
In the four decades that I have been teaching finance, I have always started my discussion of risk with a Chinese symbols for crisis, as a combination of danger plus opportunity:
Over the decades, though, I have been corrected dozens of times on how the symbols should be written, with each correction being challenged by a new reader. That said, thinking about risk as a combination of danger and opportunity is both healthy and all encompassing. It also brings home some self-evident truths about risk that we all tend to forget:
- Opportunity, without danger, is a delusion: If you seek out high returns (great opportunities), you have to be willing to live with risk (great danger). In fact, (Read more...)