1) Defining Risk

The best definition: The Chinese symbol for “risk” is a combination of Danger + Opportunity. If you want one you’ve got to live with the other. Where there is upside, there’ll always be a downside.

Distraction – Spin a big story to counter the previous one
Paradigm Shift – arguing that the rules have changed

2) Arbitrage – what is means and how it is misused in practise

  • True arbitrage is extremely rare.
  • There is no arbitrage.
  • The essence of arbitrage is that you take no risks, invest no money and walk away with a profit. In practise, what passes for arbitrage can be categorized into either pseudo or fake arbitrage. Pseudo arbitrage is categorized based on option and future pricing models. The arbitrage is dependent on both the model’s assumptions and transaction costs. Fake arbitrage categorizes everything else – merger arbitrage, paird trading arbitrage, etc. These are all speculative strategies with some or substantial risk associated with them.
  • The danger in mislabeling strategies is not only that you mislead others but that you may fall for your own hype and “finance” those strategies as if they were riskless (The Long Term Capital Curse…)
  • We have access to more data (and in a more timely form) than ever before. But our mistakes could get bigger, not smaller. The complexity of the models cannot keep up with the complexity of the assets that they are valuing. Complex model require more data inputs (with more errors) than simpler models. Complex models create output that is far more difficult to understand than simple models.

3) There is no risk in the past, it is all in the future…

  • The greatest conumdrum in finance is how we model risk based on the past because that’s where the data lies. When you use historical data, consider the error in your estimates…
  • But everything that we care about is in the future
  • Recognize that things can change in a flash

4) Risk management is everybody’s responsibility

  • Risk affects value on every dimension.
  • Valuation – Value today can be higher as a result of risk taking.
  • First thing to do – sit down and list out all possible risks. Then decide which risks you want to avoid and which to pass on to your investors.

5) Successful organizations

What risks to seek out: Those in which you have a competitive advantage on

(i) The Information Edge – Having a superior and more timely information is a clear advantage in a “risky” world 
(ii) The Speed Edge – Being able to act decisively and appropriately, once presented with the information, can help both the up and down side
(iii) The Experience/Knowledge Risk – Having been through similar risks in the past can help
(iv) The Resource Edge – Having more resources (cash, people, technology) than your competition can help

6) Secret message

Be lucky…

There is so much noise in this process that the dominant variable explaining success in any given period is luck and not skill.

Proposition 1: Today’s hero will be tomorrow’s goal – there are no experts. Let your common sense guide you.
Proposition 2: Don’t mistake luck for skill – do not over react either to success or failure. Chill.
Proposition 3: Life is not fair – you can do everything right and go bankrupt. You can do everything wrong and make millions.