More on Risk Tolerance

funky-dice.jpgThere’s a number of good comments on “Risk Appetite of Volatility Appetite,” and I’d like to respond to two of the themes.

The first is “risk appetite is an industry-standard term.” I don’t dispute this. I do question if I should care. On the one hand, terms that an industry picks up and uses tend to be useful and revelatory. Sometimes, they are also distortive. Risk appetite makes sense from the perspective of the financial industry, which is selling products of various riskiness. Knowing their customer’s appetite for risk makes sense. It makes sense even if that appetite is formed on false premises, that you must accept higher risk for a higher return. This is clearly false-just look at interest rates on insured savings accounts. A great deal of return is a function of information, and the willingness to find and use it. (Admittedly, a high interest rate may correlate with moral hazard on the part of the insured bank, and you may have to accept getting your money back later.) I think that the term risk appetite is also distortive, in that it influences the way people look at risk. I once caught myself looking for a risky investment, rather than one with a high expected upside. That high-reward investments often include lots of risk doesn’t mean it’s what I’m looking for.

The second is that I misunderstand risk. That may well be true, but I think that the goal of disaggregating risk from reward is useful. Anyone who’d like to offer up a more purely disaggregated risk is free to do so. It’s an interesting thought experiment, one that’s clearly making many readers uncomfortable. That’s not my usual goal, but I’m willing to accept it now and then in exchange for a rewarding conversation.

(These dice are from NelC, too.)

3 thoughts on “More on Risk Tolerance

  1. hmm… when I was bringing up chaumian ecash software and accompanying mint and devised a still unpatented approach to anonymous ecash via using 3 e-gold accounts(called the 3-ring circus internally) for an unamed failed corp from the dotcom.bust, the CEO of the company wanted to accept credit cards for egold calling fraud a matter of “risk management”. He was greatly surprised when the development staff quit en-masse upon hearing of his plans and has sunk back into his former life as an FC pundit.
    He simply WOULD NOT understand simply you never give cash for credit in the emoney field, to do so is to go broke.
    He thought the engineering staff didnt understand risk, obviously I and they understood it FAR better then he did.

  2. I still think that to talk about risk you must first define what you mean by it. Without a definition to anchor a discussion it’s hard to talk sensibly.
    And there *is* a strong relationship between risk and reward in finance. Check any intro economics/finance textbook for explanations of why it is so. Note — this does not mean there is a law-of-physics relationship where higher risk *always* leads to higher reward. The relationship is also much more clear on the level where professionals play, not in retail where things are often driven by marketing and stupidity.

Comments are closed.