Peter Bernstein's Evolving Thinking on Risk

<body bgcolor="#E8FFF0"> <div align="left"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table19"> <tr> <td width="740"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" height="37" id="table20"> <tr> <td height="35" width="100%"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table21"> <tr> <td> <p align="center" class="header_green"><map name="FPMap4"> <area target="5" href="../../blog051207_post.htm" shape="rect" coords="0, 0, 149, 29"> </map>Peter Bernstein's Evolving Thinking on Risk</td> </tr> </table> </td> </tr> <tr> <td width="100%" bgcolor="#CC9966" height="2"> <img border="0" src="../../../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td width="0%" valign="top" bgcolor="#FFFFCC"> <table border="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table22"> <tr> <td align="left" valign="top" bgcolor="#E8FFF0"> <p class="blog_body" align="center"> May, 12, 2006  <font size="2"> <a target="_top" href="http://www.glynholton.com/link/blog051207.htm">permalink</a></font>  <a target="5" href="../../blog051207_post.htm"> comment</a>  <a href="mailto:glyn@contingencyanalysis.com?subject=Blog Feedback"> e-mail</a></td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="345" align="left" id="table23"> <tr> <td width="336" height="14"><font size="2"> </font><font size="4"> </font></td> <td width="9" height="14"></td> </tr> <tr> <td width="336"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> <td width="9"> </td> </tr> </table> <p class="blog_body">Peter Bernstein is an elder statesman of finance. He has served time in the rough-and-tumble world of portfolio management. He was the first editor of the venerable <i>Journal of Portfolio Management</i>, and his diverse writings have made him somewhat the chronicler of twentieth century finance. He is best known for his book <i> <a target="_blank" href="http://www.amazon.com/gp/product/0471731749?ie=UTF8&tag=contingencyanaly&linkCode=as2&camp=1789&creative=9325&creativeASIN=0471731749">Capital Ideas: The Improbable Origins of Modern Wall Street</a><img src="http://www.assoc-amazon.com/e/ir?t=contingencyanaly&l=as2&o=1&a=0471731749" width="1" height="1" border="0" alt="" style="border:none !important; margin:0px !important;" /></i>. It is a wonderful book that introduces readers to the ideas of modern finance theory. Many books do the same thing through weighty mathematics. Bernstein did it with fascinating historical narratives.</p> <p class="blog_body">A problem with being a bestselling author is the fact that you have an editor who wants you to do it again and again. Bernstein, with some coaxing, has published a number of books that have never matched the brilliance of <i>Capital Ideas</i>. One of these was <i> <a target="_blank" href="http://www.amazon.com/gp/product/0471295639?ie=UTF8&tag=contingencyanaly&linkCode=as2&camp=1789&creative=9325&creativeASIN=0471295639">Against the Gods: The Remarkable Story of Risk</a><img src="http://www.assoc-amazon.com/e/ir?t=contingencyanaly&l=as2&o=1&a=0471295639" width="1" height="1" border="0" alt="" style="border:none !important; margin:0px !important;" /></i>. This was Bernstein's history of risk. Tacitly identifying risk with risk measurement, it was largely a non-technical history of the development of probability theory. There are better histories of probability theory, but this didn't matter. Bernstein was a star, and the book sold healthily. </p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="345" align="right" id="table24"> <tr> <td align="right" width="9"> </td> <td width="336"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> </table> <p class="blog_body">Since then, Bernstein has frequently commented on risk, and it has been interesting to watch his ideas evolve. It is as if he first wrote the book on risk and later became an expert. Perhaps the most telling indication of how far his thinking has come from the risk-measurement focus of <i>Against the Gods</i> are remarks he made at a CFA Institute symposium in February 2006:</p> <p class="blog_body" style="margin-left: 15px">I am increasingly concerned with how the risk management business today focuses so intently on the tools of risk measurement—probability, normal curve, sampling, regression to the mean, mean-variance. To me, risk management is not about measurement at all. It is about how we make decisions and only incidentally about the math we use in making those decisions. If we stare at just the models and equations, we lose sight of the mystery of life—we lose sight of the unknown. There would be no such thing as risk if everything were known. If only a finite number of things could happen, risk would not exist. Even the most brilliant mathematical genius will never be able to tell us what the future holds. <i>What matters in thinking about risk is the quality of the decisions we make in the face of uncertainty.</i></p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="345" align="right" id="table25"> <tr> <td align="right" width="9"> </td> <td width="336"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> </table> <p class="blog_body">I have long held a similar view. In my 2004 paper <i> <a target="_blank" href="http://www.riskexpertise.com/papers/risk.pdf">Defining Risk</a></i>, I concluded that it is impossible to define risk. We speak intuitively of risk, but there is no "true risk." At best, we can define perceived risk—a far less compelling notion. Risk metrics such as volatility, delta or value-at-risk, are really metrics of perceived risk. In my paper, I elaborated</p> <p class="blog_body" style="margin-left: 15px">What is risk? How can we quantify risks that cannot be perceived? If a trader or business manager has knowledge that is not reflected in a risk metric, does the risk metric misrepresent risk? In the absence of true risk, these questions are empty. A more practical question is whether a risk metric is useful. Used in a given application, will it promote behavior that management considers desirable?</p> <p class="blog_body">So why discuss Bernstein now? He has a new book out called <i> <a target="_blank" href="http://www.amazon.com/gp/product/0471731730?ie=UTF8&tag=contingencyanaly&linkCode=as2&camp=1789&creative=9325&creativeASIN=0471731730">Capital Ideas Evolving</a><img src="http://www.assoc-amazon.com/e/ir?t=contingencyanaly&l=as2&o=1&a=0471731730" width="1" height="1" border="0" alt="" style="border:none !important; margin:0px !important;" /></i>. This is a follow-up to <i>Capital Ideas</i>. Picking up where the earlier book leaves off, it focuses on subsequent developments in both finance theory and practice. Bernstein's new thinking on risk is front-and-center. Indeed, I now perceive his comments at the 2006 symposium as just a preview.</p> <p class="blog_body" align="center"> Glyn A. Holton</p> <p class="blog_body" align="left"> <img border="0" src="../images/bullet_link_blog.gif" width="26" height="15" align="absbottom"><a target="_blank" href="http://www.amazon.com/gp/product/0471731749?ie=UTF8&tag=contingencyanaly&linkCode=as2&camp=1789&creative=9325&creativeASIN=0471731749">See Peter Bernstein's book <i> Capital Ideas</i></a><br> <img border="0" src="../images/bullet_link_blog.gif" width="26" height="15" align="absbottom"><a target="_blank" href="http://www.amazon.com/gp/product/0471295639?ie=UTF8&tag=contingencyanaly&linkCode=as2&camp=1789&creative=9325&creativeASIN=0471295639">See Peter Bernstein's book <i> Against the Gods</i></a><i><img src="http://www.assoc-amazon.com/e/ir?t=contingencyanaly&l=as2&o=1&a=0471295639" width="1" height="1" border="0" alt="" style="border:none !important; margin:0px !important;" /></i><br> <img border="0" src="../images/bullet_link_blog.gif" width="26" height="15" align="absbottom"><a target="_blank" href="http://www.riskexpertise.com/papers/risk.pdf">Read Glyn Holton's paper <i> Defining Risk</i></a><br> <img border="0" src="../images/bullet_link_blog.gif" width="26" height="15" align="absbottom"><a target="_blank" href="http://www.amazon.com/gp/product/0471731730?ie=UTF8&tag=contingencyanaly&linkCode=as2&camp=1789&creative=9325&creativeASIN=0471731730">See Peter Bernstein's book <i> Capital Ideas Evolving</i></a><i><img src="http://www.assoc-amazon.com/e/ir?t=contingencyanaly&l=as2&o=1&a=0471731730" width="1" height="1" border="0" alt="" style="border:none !important; margin:0px !important;" /></i><br>  </p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" height="37" id="table26"> <tr> <td height="35" width="100%"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table27"> <tr> <td width="100%"> <p align="center"><map name="FPMap0"> <area target="5" href="../../blog051207_post.htm" shape="rect" coords="0, 0, 149, 29"> </map> <img border="0" src="../images/button_comment.gif" usemap="#FPMap4" width="150" height="30"><p align="center"> </td> </tr> </table> </td> </tr> <tr> <td width="100%" bgcolor="#CC9966" height="2"> <img border="0" src="../../../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td width="0%" valign="top" bgcolor="#FFFFCC"> <table border="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" cellspacing="1" id="table28"> <tr> <td align="left" valign="top" bgcolor="#E8FFF0">  </td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table29"> <tr> <td bgcolor="#FFFFCC"> <table border="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" bgcolor="#E8FFF0" id="table30"> <tr> <td width="100%" bgcolor="#E8FFF0"> <p align="center" style="margin-top: 18"><map name="FPMap2"> <area target="_top" href="http://www.glynholton.com" shape="rect" coords="0, 0, 192, 76"> </map> <img border="0" src="../images/logo_blog_green.gif" width="193" height="77" usemap="#FPMap2"></p> <p align="center"><span class="verdana10"> <a href="http://www.riskglossary.com/main/disclaimer.htm" target="_self"> Disclaimer</a></span></p> <p align="center">website: <a target="_top" href="http://www.contingencyanalysis.com"> http://www.contingencyanalysis.com</a><br> blog direct link: <a target="_top" href="http://www.glynholton.com"> http://www.glynholton.com</a><br> copyright © Contingency Analysis, 2007<p align="center"> <map name="FPMap3"> <area target="_top" href="http://www.contingencyanalysis.com" shape="rect" coords="0, 0, 240, 88"> </map> <img border="0" src="../images/logo_ca_green.gif" width="241" height="89" usemap="#FPMap3"></td> </tr> </table> </td> </tr> </table> </td> <td>  </td> </tr> </table> </div>  </body>