Comments on: Volatility and Risk http://www.sharpeinvesting.com/2007/06/volatility-and-risk.html The Advanced Finance and Investing Resource Thu, 09 Sep 2010 03:27:16 +0000 http://wordpress.org/?v=2.5.1 By: mike http://www.sharpeinvesting.com/2007/06/volatility-and-risk.html#comment-2654 mike Thu, 20 May 2010 02:08:20 +0000 http://www.sharpeinvesting.com/?p=13#comment-2654 The assumption that an asset with large price swings is more risky than an asset that is not volatile is flawed. It may just mean that there is less liquidity in the less volatile asset. A house price may be fairly stable over a number of years, but if that price is way above the actual value, buying the house may be more risky than investing in a security for example. See this quote below from Warren Buffet's letter to shareholders. "Volatility is not a measure of risk. The people who teach risk in universities do not understand risk. Beta does not measure risk. Warren gave the example of farmland in Nebraska in the early 1980s, which he purchased at $600 an acre. Two years earlier, it was selling for $2000 an acre. However, when farmland was selling at $2000 an acre, its beta was lower. Thus, according to financial theory, farmland was less risky at $2000 an acre than it was at $600 an acre. Volatility as a measure of risk is nonsense." The assumption that an asset with large price swings is more risky than an asset that is not volatile is flawed. It may just mean that there is less liquidity in the less volatile asset.

A house price may be fairly stable over a number of years, but if that price is way above the actual value, buying the house may be more risky than investing in a security for example.

See this quote below from Warren Buffet’s letter to shareholders.

“Volatility is not a measure of risk. The people who teach risk in universities do not understand risk. Beta does not measure risk. Warren gave the example of farmland in Nebraska in the early 1980s, which he purchased at $600 an acre. Two years earlier, it was selling for $2000 an acre. However, when farmland was selling at $2000 an acre, its beta was lower. Thus, according to financial theory, farmland was less risky at $2000 an acre than it was at $600 an acre. Volatility as a measure of risk is nonsense.”

]]> By: Matt http://www.sharpeinvesting.com/2007/06/volatility-and-risk.html#comment-1694 Matt Tue, 12 Aug 2008 00:50:42 +0000 http://www.sharpeinvesting.com/?p=13#comment-1694 Thanks again for the compliment Max. It has been very interesting to watch the VIX this year, as the markets have been very volatile. Thanks again for the compliment Max. It has been very interesting to watch the VIX this year, as the markets have been very volatile.

]]> By: Max http://www.sharpeinvesting.com/2007/06/volatility-and-risk.html#comment-1691 Max Mon, 11 Aug 2008 18:36:28 +0000 http://www.sharpeinvesting.com/?p=13#comment-1691 Please keep these excellent posts coming. Please keep these excellent posts coming.

]]> By: Matt http://www.sharpeinvesting.com/2007/06/volatility-and-risk.html#comment-244 Matt Sat, 22 Sep 2007 14:50:09 +0000 http://www.sharpeinvesting.com/?p=13#comment-244 You brought up some very good points Rob. Thanks for the great comment! You brought up some very good points Rob. Thanks for the great comment!

]]> By: Rob Viglione http://www.sharpeinvesting.com/2007/06/volatility-and-risk.html#comment-204 Rob Viglione Tue, 18 Sep 2007 00:39:00 +0000 http://www.sharpeinvesting.com/?p=13#comment-204 What is often lacking in financial models is the incorporation of low probability, but high impact events. A decent read on the topic (although it could do a better job of getting to the point) is the Misbehavior of Markets, by Mandelbrot. Volatility estimates, by virtue of construction with historical data, tend to smooth catastrophic events with normal data. The key to surviving financial catastrophe is to develop rigorous risk management procedures to ensure the bulk of your assets can weather a severe financial storm. The only way to do this is through sufficient diversification, ensuring that your aggregate portfolio contains offsetting correlations that truly minimize beta. This is far trickier than it sounds! What is often lacking in financial models is the incorporation of low probability, but high impact events. A decent read on the topic (although it could do a better job of getting to the point) is the Misbehavior of Markets, by Mandelbrot. Volatility estimates, by virtue of construction with historical data, tend to smooth catastrophic events with normal data. The key to surviving financial catastrophe is to develop rigorous risk management procedures to ensure the bulk of your assets can weather a severe financial storm. The only way to do this is through sufficient diversification, ensuring that your aggregate portfolio contains offsetting correlations that truly minimize beta. This is far trickier than it sounds!

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