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1/ It is easy and natural for humans to confuse risk of ruin with volatility.
Volatile things are not necessarily high risk, and nonvolatile things are not necessarily a low risk.
What are some good examples of where people commonly make this mistake?
Volatile things are not necessarily high risk, and nonvolatile things are not necessarily a low risk.
What are some good examples of where people commonly make this mistake?
2/ Great joke about leveraged deep value investors which captures the idea of ergodicity and risk of ruin beautifully:
“It looks ok at 100, it looks good at 90, it looks great at 80, it looks absolutely fantastic at 70, and you’re out of business at 60.”
“It looks ok at 100, it looks good at 90, it looks great at 80, it looks absolutely fantastic at 70, and you’re out of business at 60.”
3/ Crossing a river that is 4ft. deep on average, with flat, mildly sloping edges where you can easily wade but a 10ft. deep, fast current in the middle is much riskier than crossing a river with an undulating and uneven riverbed but without the deep channel.
4/2008 financial crisis: Leading up to 2007, mortgage bonds and the derivatives associated with them had extremely low levels of measurable volatility.
As many investors found out, this was a poor measure of risk.
As many investors found out, this was a poor measure of risk.
5/ What are some other real-world examples (both in markets but also more broadly) that demonstrate this?
6/ Maybe another way of saying this more succinctly:
The problem of modernity is that our intuitions are ergodic, but our reality is not.
The problem of modernity is that our intuitions are ergodic, but our reality is not.
