Aaron Brown develops a nice concept on how to look at risk. Risk is just the combination of danger on the downside and opportunity on the upside. If risk can be represented by the bell-shaped distribution of pay-offs, then you have to look at both side of the distribution to determine what action should be taken.
The problem is that danger and opportunities cannot often be measured and if they can be measure they are often in different units. The bell-shaped world of the normal distribution is the exception not the norm. Dangers and opportunities are inherent in nature, but risk is how these interact within the actions we take. Dangers exist but or not relevant until we take an action. We have opportunities but these do not occur until we try to seize them. This is what makes risk management so difficult. The choice of the individual is whether dangers should be avoided and whether opportunities should be seized.
The risk-taker has to ensure that he has a positive expected return, that his bets are independent and not taken over and over, and he must size risks so as not to cause undue harm. This is applied to all parts of life and is not an issue that is just relegated to finance.
No comments:
Post a Comment