What About Risk?
Over the last couple of years, particularly considering the collapse of our capital markets, we have begun to fear risk (defined by uncertainty of the future) and supplant capital investment with the certainty of cash and short term liquidity. These trends, while natural considering the events of the last couple years, have forced risk loving market participants to generally take a back seat and become risk adverse. Now that we are beyond the point, where the markets will come crashing down, the sky can now stop raining cats and dogs, and we can all return to a point of normalcy where the natural balance between risking loving and hating are in equilibrium. I know George Soros is not a fan of ‘equilibrium’ persay, but we can all agree that there is a natural balancing point in the short term, also known as the price level, where both supply and demand or buy and sell sides are content.
I recently came across a McKinsey quarterly article entitled “The Use and Abuse of Scenarios“, of which, I found extremely intriguing – particularly the video by Peter L. Bernstein the author of the book “Against the Gods: The Remarkable Story of Risk”. Even if you are not an aspiring mathematician or or statistician I would encourage anyone to pick up the book. It is definitely a complementary read for people in an analytical career or hobbiest.
Given the complexity of the 2008 recession, and events leading up to it, I am left to wonder if we have really learned anything from the mistakes of the past, and have improved our ideological framework to include advanced risk evaluation techniques. I am not saying that every form of risk has to be quantifiable, clearly real options exist, to help alleviate qualitative risks that are often difficult to identify or plan for. As we have seen from the past, quantitative tools and methods are not necessarily the only / best option; however, they are an option that should be widely implemented. I feel if many of the financial institutions and insurance firms had been a little bit more risk adverse, not only in their risky assets, but also in their underwriting standards, full risk hedging and systemic risk may have been substantially reduced or eliminated.
Are we primed to have risk lovers return to the market place (capital markets and corporate investment)? Have major corporations proven that they have the tools and resources to accurately assess and hedge risk? Are our modern risk assessment models flawed and do we need an entirely new framework to address risk moving forward?
Feel free to watch the videos below and comment.