tag:blogger.com,1999:blog-17232051.post1070541441664728996..comments2022-01-28T00:36:30.426-05:00Comments on Noahpinion: Risk is immeasurableNoah Smithhttp://www.blogger.com/profile/09093917601641588575noreply@blogger.comBlogger34125tag:blogger.com,1999:blog-17232051.post-81537193782422568022013-08-26T20:22:40.129-04:002013-08-26T20:22:40.129-04:00While it's true that we can't get a pictur...While it's true that we can't get a picture of historical (or prospective) risk just by looking at a price chart, perhaps we could get a better idea by having a model of the fundamentals of the asset? For instance, if you know that GM is basically a stable machine that turns out 5 million cars a year and sells them to 5 million people, you can sensibly say that it's lower risk than a defense contractor or an investment bank specialising in IPOs, which do 10 deals a year but make a billion dollars (or lose half a billion) on each of them.<br /><br />Of course there are external factors you can't predict, such as a Toyota recall or a downturn in availability of cheap auto finance. But you can probably still say that Wal-Mart is lower risk than Goldman, or at least is likely to have lower variance in its daily price or quarterly profits.<br /><br />Not that I disagree with your philosophical point, I just might moderate the claim a little.Leigh Caldwellhttps://www.blogger.com/profile/16150868700502562500noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-15904340418241651722013-08-22T22:00:55.956-04:002013-08-22T22:00:55.956-04:00Noah,
You have plotted nearly 30 years of volatil...Noah,<br /><br />You have plotted nearly 30 years of volatility and are troubled by spikes probably lasting in months, and in that time, millions of contracts on S&P were traded... probably valued in multi-billions of dollars.<br /><br />I think you are trying to formalize something that is unrealistic at the time scale you have chosen.KVnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-89342266925228311342013-08-20T12:38:59.262-04:002013-08-20T12:38:59.262-04:00Noah, you have to have this all wrong.
Our &quo...Noah, you have to have this all wrong. <br /><br />Our "Makers" have to be able to measure risk. Otherwise how can they be expected to function? We all know how very very sensitive to uncertainty our super heroic makers are. But you did not think about that, did you ?<br /><br />I expect a retraction ! Wake up !Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-3848566976044974472013-08-20T12:09:34.512-04:002013-08-20T12:09:34.512-04:00No, I think you just don't understand what I&#...No, I think you just don't understand what I'm trying to say. Which is of course my fault for not explaining well.<br /><br />Try this: Given V(0) and V(T), the value of my portfolio at the time I start investing and the time I cash out, my utility does not depend on V(t) for any 0<t<T. <br /><br />Does that make sense now? Noah Smithhttps://www.blogger.com/profile/09093917601641588575noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-23218927039265759522013-08-20T09:01:08.225-04:002013-08-20T09:01:08.225-04:00You are getting at something I pointed out to Noah...You are getting at something I pointed out to Noah and the other (academics I think :-) ). BOTH return and risk are parameter draws from a realised distribution. We cannot know with any foresight (at least systematically) what these are going to be. <br /><br />It is true that you can pretend that return is simply [P(T)/P(0) - 1]. However what if we say that actual leverageable return is really [P(T)/P(0) - 1]/Sigma(0,T)? (Instead of Sigma you can use any other measure of dispersion)<br /><br />In fact that is how the investment eco-system works! Also I think human behaviour works the same way. Highly volatilie wealth will make people behave very differently than more stable wealth.<br />Som Dasguptahttps://www.blogger.com/profile/11848089230329819807noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-43625722538632394552013-08-20T08:32:29.885-04:002013-08-20T08:32:29.885-04:00Risk has a probability.
Probabilities can be mea...Risk has a probability. <br />Probabilities can be measured.<br />Returns on investment are a function of demand, they are conditional on the state of the economy. In a demand shock recession, returns may drop due to slack demand and over capacity. While returns can be measured in the present, returns in the future cannot. They have risk, or a probability of being over or under estimate.<br /><br />Investment decisions are based on rate of return and demand. This is where monetary policy runs into difficulty at the ZLB. Monetary policy can increase the rate of return if interest rates are lowered. But the returns cannot be realized if demand is slack. Fighting a recession at the ZLB requires restoration of demand before investors will risk investment in new or additional production.<br />-jonny bakhoAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-85595516931846119022013-08-20T08:07:10.947-04:002013-08-20T08:07:10.947-04:00Oh dear. I think you were in a stronger position b...Oh dear. I think you were in a stronger position before you defended yourself.Phil Koopnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-19566623506049780212013-08-20T07:56:09.100-04:002013-08-20T07:56:09.100-04:00Its nice to to think that all you care about is th...Its nice to to think that all you care about is the realized return and totally avoid the path dependent nature of pretty much all returns today (even your own Personal Account, which gets Reg T treatment, and shut down if you don't post requisite collateral.). <br /><br />Return per unit of realised risk is how money management is assessed today. Then there is the ISDA, which measures expected risk and exchanges collateral based on each day's m-t-m risk. Most importantly there are fairly deep markets in variance and correlation, which can hedge these risks.<br /><br />So just like realized return, there is also realized risk, which are both just single draws from a distribution which we will hardly know with anything like perfect foresight. However both matter with pretty much equal importance. Try to raise money by promising 15% return with 45% p/l volatility and see what happens!<br /><br />Anyway this is a good post!<br /><br />P.S. About the only thing that might get around the issue of realized risk is trading you own in a cash account (no leverage). Even then you should be comparing this to return per unit of risk and taking your own temperature from time to time.Som Dasguptahttps://www.blogger.com/profile/11848089230329819807noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-67863522418153366072013-08-20T00:42:04.141-04:002013-08-20T00:42:04.141-04:00Usually there is a *market hardening* after an adv...Usually there is a *market hardening* after an adverse event. Insurance is priced by people and people get spooked. Capital doesn't flow perfectly freely and no one knows what actuarialy fair rate is. If actuaries use historical data, which is primarily how rates are calculated, then a recent big loss impacts those calculations.The 26thhttps://www.blogger.com/profile/06581159213054051562noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-44911361748352790772013-08-20T00:00:10.439-04:002013-08-20T00:00:10.439-04:00As others have noted, this is essentially the star...As others have noted, this is essentially the starting point of Keynes's analysis.JW Masonhttps://www.blogger.com/profile/10664452827447313845noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-11182305638495775572013-08-19T23:06:29.338-04:002013-08-19T23:06:29.338-04:00Very interesting post. I think there are differen...Very interesting post. I think there are different ways to define risk vs uncertainty. <br /><br />1. A situation that is well defined, the probability distribution is fixed and known, but the outcome is unknown. <br /><br />2. The situation is not well defined, the probability distribution is fixed, but unknown. The outcome is unknown. <br /><br />3. The situation is not well defined, the probability distribution is constantly changing and unknown at any given time. The outcome is unknowable. <br /><br />#1 Can be called risk. <br />#2 Can be called epistemological uncertainty.<br />#3 Can be called ontological uncertainty. <br /><br />Really, you can call these conditions whatever you would like but they are all different. #2 is closer to how Knight defined uncertainty where #3 is closer to how Keynes defined uncertainty.<br /><br />A situation is "well defined" when the variables that affect the probability distribution are known.<br /><br />In an uncertain situation, the variables are not know as humans possess imperfect knowledge. The difference between #2 and #3 goes one step further. Not only are the variables unknown, but even if they were known, the relationships the variables have with one another is subject to change. <br /><br />#2 suggest that if humans possessed perfect knowledge or had a machine that allowed this (advanced computers), all variables in the present could be known and their relationships with one another could be revealed. If this was possible, uncertainty involving the future could be quantified. With perfect knowledge uncertainty can be reduced to risk. Risk can be managed. <br /><br />#3 suggest that even if one possesses perfect knowledge of all variables and their relationships with one another, uncertainty could still never be quantified. This is because the nature of the variables is subject to change and their relationships with each other are not fixed. Furthermore, new variables can come into existence. Therefore, even with perfect knowledge, uncertainty is not reducible. <br /><br />See:<br />Keynes and Knight on uncertainty – ontology vs. epistemology<br />http://larspsyll.wordpress.com/2012/07/29/keynes-and-knight-on-uncertainty-ontology-vs-epistemology/Rafael Barbierihttps://www.blogger.com/profile/01578692617118123417noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-91337750029746204052013-08-19T21:40:58.381-04:002013-08-19T21:40:58.381-04:00you may want to read up on GARCH during your winte...<i>you may want to read up on GARCH during your winter break</i><br /><br />Winter? Are you in Australia or New Zealand??Noah Smithhttps://www.blogger.com/profile/09093917601641588575noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-5957188773436134972013-08-19T18:41:07.634-04:002013-08-19T18:41:07.634-04:00it's not that difficult to determine:
1)what ...it's not that difficult to determine:<br /><br />1)what price you'll get when you sell and <br />2) your return <br />3)the proceeds<br /><br />1. is determined by looking at the bid of the bid/ask spread. but for a very big order you will get a lower price and to determine this price you may need a more complicated method , but for a highly liquid stock and a modest sized order your execution price is going to be the quoted 'bid', give or take a few tenths of a percent.<br /><br />2. your % returns is simply the final capital divided by the starting. easy. nominal is just = final - starting<br /><br />3. the proceeds of a sale is determined by taking the integral of the price function from t_o to t_1 upon the addition of your sell orders to find the mean value and multiply this by the number of shares sold. this can be hard but like 1., for the majority of cases its just the order size times the bid price.<br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-13827307056306468412013-08-19T16:23:11.416-04:002013-08-19T16:23:11.416-04:00Shouldn't insurance premium reflect the actuar...Shouldn't insurance premium reflect the actuarial fair price, and not the demand aspect?<br /><br />Can an economist/finance/quant weigh in on this? I'm thinking that Max has a good point. Seems to me that insurance premiums overreact to the disaster? Jefftopiahttps://www.blogger.com/profile/05005211633248766565noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-81614480310581900682013-08-19T16:20:27.568-04:002013-08-19T16:20:27.568-04:00This is a category mistake.
Noah's article i...This is a category mistake. <br /><br />Noah's article is about *measures* of risk. GARCH is a method used to *estimate* a measure of risk. <br /><br />Still, GARCH is a handy thing to know. Jefftopiahttps://www.blogger.com/profile/05005211633248766565noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-31598170111471791002013-08-19T15:39:44.518-04:002013-08-19T15:39:44.518-04:00Asset allocation (and re-balancing) uses simple ar...Asset allocation (and re-balancing) uses simple arithmetic to address risk. this is not very adventurous (nor yields highest returns) but it is simple and modestly safe. And for most people owning an affordable house, along with an affordable 30 year mortgage is again not adventurous but almost always safe. (not all that many Detroits) RLLhttps://www.blogger.com/profile/13850927095383579725noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-46182422858545369872013-08-19T15:07:09.642-04:002013-08-19T15:07:09.642-04:00you may want to read up on GARCH during your winte...you may want to read up on GARCH during your winter break,<br /><br />thanks for posting and enjoy the break!Patrickhttps://www.blogger.com/profile/06658507365116962150noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-49203342419984409622013-08-19T14:59:08.242-04:002013-08-19T14:59:08.242-04:00A natural disaster can increase the demand for ins...A natural disaster can increase the demand for insurance and decrease the supply - hence higher prices until the insurance industry rebuilds its capital and homeowners become complacent.Absalonhttps://www.blogger.com/profile/09131268683451462949noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-90561031787055772712013-08-19T13:55:39.589-04:002013-08-19T13:55:39.589-04:00we'll never know how much we know about it
Ca...<i>we'll never know how much we know about it</i><br /><br />Call Rumsfeld, he'll straighten this all out.mattskihttps://www.blogger.com/profile/07936264188400397646noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-35858415638176159022013-08-19T13:47:42.764-04:002013-08-19T13:47:42.764-04:00After a natural disaster, insurance premiums go up...After a natural disaster, insurance premiums go up, even if there's no reason why the disaster should alter our estimate of risk.<br /><br />Stock markets seem to have the same property: they compensate investors for past losses, not for risk.<br />Maxnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-39123355828712249382013-08-19T13:46:45.848-04:002013-08-19T13:46:45.848-04:00Go get'em!Go get'em!PeterPhttps://www.blogger.com/profile/02032621777697914182noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-79957457214679627192013-08-19T13:03:48.520-04:002013-08-19T13:03:48.520-04:00It is often argued that Knight and Keynes in 1921 ...It is often argued that Knight and Keynes in 1921 co-invented the distinction between risk and uncertainty, although it was Knight who first used those terms. This is tied to the fact that the view Keynes put forth in his Treatise on Probability was more nuanced, subtle, and complicated, and more relevant to the points you are making here, Noah, along with people like Lo and Mueller.<br /><br />For Knight there were the two categories: quantifiable risk and unquantifiable uncertainty. Keynes allowed for more intermediate forms. "Radical" Keynesian uncertainty resembles Knightian uncertainty, there is no probability distribution at all. At the other extreme there is not only a probability distribution, but it is easily known and categorized, as in the canonical case of flipping a "fair" coin (let us avoid the problem of how we know a coin is "fair" or not).<br /><br />But there are these intermediate cases, several of which have been mentioned. So, there may be a probability distribution, but for a variety of reasons, including simply not being able to make enough relevant observations, we cannot determine it with any degree of certainty. Or then there is the matter that opened the discussion, that even if the distribution is known, there may be competing ways of characterizing its riskiness or volatility. Variance works fine if one has a Gaussian distribution, but other measures may be more appropriate when there is skewness or kurtosis. This latter case is what Taleb refers to as "grey swans" to contrast with the black swans of deeper and truer uncertainty.rosserjb@jmu.eduhttps://www.blogger.com/profile/09300046915843554101noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-602808518058192013-08-19T12:56:05.688-04:002013-08-19T12:56:05.688-04:00Nah, I'm starting my own school of economic th...Nah, I'm starting my own school of economic thought. Post-Keynesianism is yesterday's news.Noah Smithhttps://www.blogger.com/profile/09093917601641588575noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-78235393720141408732013-08-19T12:33:40.879-04:002013-08-19T12:33:40.879-04:00So are you a Post Keynesian now? Forget about gett...So are you a Post Keynesian now? Forget about getting published ;)PeterPhttps://www.blogger.com/profile/02032621777697914182noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-60833318510452383832013-08-19T12:16:18.386-04:002013-08-19T12:16:18.386-04:00Very true!Very true!Noah Smithhttps://www.blogger.com/profile/09093917601641588575noreply@blogger.com