Honey, I Broke the Markets
“Donald Trump looks like the villain in a movie where the hero is a dog.”
– The internet.
Which four letter word still has an amazing capacity to cause offence, anxiety and aggravation ? In the world of investment, that word would have to be
R-I-S-K.
Do we even have a workable definition of what it means ?
Author Guy Fraser-Sampson, in ‘The Pillars of Finance’, points out that before the Second World War, financial thinkers had a somewhat humbler perspective on the subject:
“..while before the War there was eager discussion as to what risk might be, and whether it was the same thing as uncertainty, there was total agreement that whatever it was it was probably too complex an animal ever to be fully understood and, in particular, that it was incapable of mathematical calculation.” [Emphasis ours.]
The American academic Frank Knight published ‘Risk, Uncertainty and Profit’ in 1921. As he wrote, some forms of uncertainty are measurable. There is, for example, empirical observation with regard to the occurrence of a number of discrete outcomes, such as the rolling of dice.
Then there is ‘true uncertainty’, such as the chances of a house in a particular area catching fire in any given year. The probability of dice throws is capable of mathematical calculation – albeit the outcome is still not guaranteed – whereas the chance of a house burning down is not. In relation to fire insurance, we can only use statistical inferences drawn from prior observation.
“The import of this distinction.. is that the first.. type of probability is practically never met with in business, while the second is extremely common. It is difficult to think of a business ‘hazard’ with regard to which it is any degree possible to calculate in advance the proportion of distribution among the different possible outcomes. This must be dealt with, if at all, by tabulating the results of experience. The ‘if at all’ is an important reservation.”
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