risk tolerance

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All About Asset Allocation, Second Edition by Richard Ferri

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asset allocation, asset-backed security, barriers to entry, Bernie Madoff, capital controls, commodity trading advisor, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, equity premium, estate planning, financial independence, fixed income, full employment, high net worth, Home mortgage interest deduction, implied volatility, index fund, Long Term Capital Management, Mason jar, mortgage tax deduction, passive income, pattern recognition, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sharpe ratio, too big to fail, transaction costs, Vanguard fund, yield curve

The advisor explains the historical returns and risks of each asset class, how modern portfolio theory works, and the necessity for annual rebalancing. The advisor asks the woman to complete a risk tolerance questionnaire to find the maximum level of risk she can deal with. The woman completes the risk tolerance questionnaire, and the financial planner calculates the results. He concludes that the woman has the risk tolerance to handle an aggressive portfolio. The advisor suggests an asset allocation of 70 percent in stocks and 30 percent in bonds. Before recommending individual investments, the planner wishes to ensure that a 70 percent stock and 30 percent bond portfolio is not above the woman’s risk tolerance. Therefore, he asks her to take an asset allocation stress test. A hypothetical portfolio is created to simulate the month-bymonth value of a 70 percent stock and 30 percent bond portfolio between the years 2000 and 2002.

Cash income created by current investments can be reinvested where needed if it is not withdrawn. Being consistent with rebalancing is also a good test of risk tolerance. Investors will rebalance at the appropriate time without hesitation if their portfolio is within their risk tolerance. A portfolio’s asset allocation may be too aggressive if an investor hesitates on rebalancing in a bear market. If you are hesitant when stocks are suffering, it may be time to rethink your plan and make a permanent adjustment to the stock and bond mix. WHEN TO USE RISK AVOIDANCE Risk avoidance is a different concept from risk tolerance. Risk avoidance is a conscious decision not to invest up to your known risk tolerance level. This is a risk control measure. You take only the amount of risk that you need to accomplish a financial objective.

Only those investors who have an asset allocation at or below their tolerance for risk survive deep bear market. Finding an investment allocation that will survive during all market cycles is not easy, but it is worth the effort. RISK TOLERANCE QUESTIONNAIRES Risk tolerance questionnaires are common in the investment industry. Questionnaires are available through all mutual fund companies, brokerage firms, and private investment advisors. In addition, you can find them in financial planning books and in some investment-related magazines. The goal of risk tolerance questionnaires is to find the maximum level of risk that an investor is capable of handling. In doing so, they ask various questions about your investment experience and try to model your risk-and-return profile. Some go as far as recommending an appropriate mix of investments based on your answers.


pages: 368 words: 145,841

Financial Independence by John J. Vento

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Affordable Care Act / Obamacare, Albert Einstein, asset allocation, diversification, diversified portfolio, estate planning, financial independence, fixed income, high net worth, Home mortgage interest deduction, mortgage debt, mortgage tax deduction, oil shock, Own Your Own Home, passive income, risk tolerance, time value of money, transaction costs, young professional, zero day

Because the question of your own personal risk tolerance revolves around human behavior and emotions, it is important to understand your own investment psychology. I consider this the investor’s psychological evaluation of his or her risk tolerance. There are many ways to measure your risk tolerance and numerous questionnaires are provided at many investment websites. You can also find one at http://finance.yahoo.com/calculator; scroll down to “Career & Education” and click on “What is my risk tolerance?” You will find 10 risk tolerance questions to help identify your comfort level with investment risk. Exhibit 9.1 provides a simplified version of a risk investment, risk profile questionnaire. Please take a few moments to answer these questions to determine your own investor risk tolerance profile and score. c09.indd 223 26/02/13 2:51 PM 224 Financial Independence (Getting to Point X ) Exhibit 9.1 Six Questions to Assess Your Investor Risk Tolerance Profile and Score 1.

This may have been best said by Warren Buffett, the primary shareholder, chairman, and CEO of Berkshire Hathaway, who is also considered by many to be the most successful investor of the twentieth century: Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value. The information and guidance on investments that I provide in this chapter is designed to help you stay the course toward financial independence and your point X. Analyzing Your Risk Tolerance Every investor has his own unique view on risk and can only tolerate a certain amount of losses before he or she becomes emotional. This ultimately leads to bad investment decisions. Of course, a higher level of risk corresponds to the potential for a higher rate of return on your investments. If your investing risk tolerance were as simple as stating you want the highest rate of return in the long run, then you would simply invest in the most speculative types of investments. But it is not that simple; instead, you need to examine your own personal tolerance to risk so that the ultimate investment portfolio you choose will have staying power in both good and bad times.

The appropriate investment plan for you should be the one that provides you with the highest potential rate of return in the long run that is within your risk tolerance. Part of determining your risk tolerance goes back to analyzing your personal behavior and how you deal with your other life issues. For example, if you typically are a nervous individual and tend to go down the straight-and-narrow path in life, then you most likely will choose a more conservative investment risk model. On the other hand, if you are fearless and like to live life in the fast lane, then you would most likely choose a more aggressive investment risk model. In evaluating your risk tolerance, you must also take into consideration what your ultimate financial goals will be. This will help you determine your time horizon. Generally, the shorter your time horizon, the less risk you should be willing to take on.


pages: 320 words: 33,385

Market Risk Analysis, Quantitative Methods in Finance by Carol Alexander

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asset allocation, backtesting, barriers to entry, Brownian motion, capital asset pricing model, constrained optimization, credit crunch, Credit Default Swap, discounted cash flows, discrete time, diversification, diversified portfolio, en.wikipedia.org, implied volatility, interest rate swap, market friction, market microstructure, p-value, performance metric, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, statistical arbitrage, statistical model, stochastic process, stochastic volatility, transaction costs, value at risk, volatility smile, Wiener process, yield curve

The answer is his absolute risk tolerance. For instance, suppose you are willing to bet 1 million on a gamble where you are returned either 2 million or 500,000 but you are not willing to bet more than this for a ‘double-or-half’ gamble. Then your coefficient of absolute risk tolerance is 106 (measured in ) and your absolute risk aversion coefficient is 10−6 (measured in −1 ). Similarly, to determine the relative risk tolerance of a risk averse investor, which is the reciprocal of his relative risk aversion coefficient, we should present him with the following question. Suppose you can gamble a certain proportion x of your wealth W on a lottery where you receive either 2(xW) or 21 xW with equal chances. What is maximum proportion x that you are willing to bet? The answer is his relative risk tolerance. For instance, suppose you are willing to bet 20% of your total net wealth on a gamble where you are returned either double your net wealth or one half of it with equal chances, but you are not willing to bet more than this for a ‘double-or-half’ gamble.

Example I.6.4: Higher moment criterion for an exponential investor Two portfolios have the returns characteristics shown in Table I.6.3. An investor with an exponential utility has 1 million to invest. Determine which portfolio he prefers when he invests: $ $ $ $ $ $ $ (i) 1 million and his absolute risk tolerance coefficient is 200,000; (ii) 1 million and his absolute risk tolerance coefficient is 400,000; (iii) 1 million and his absolute risk tolerance coefficient is 100,000; (iv) only 0.5 million and his absolute risk tolerance coefficient is 100,000. $ 11 $ This approximation only holds when x is small. It follows from the expansion of ln1 + x given in Section I.1.2.5. Introduction to Portfolio Theory 237 Table I.6.3 Returns characteristics for two portfolios Portfolio Mean A B 10% 15% Standard deviation Skewness Excess kurtosis −05 −075 2.5 1.5 12% 20% Solution (i) The absolute risk aversion coefficient, as a proportion of the amount invested, is = $1000000 = 5 $200000 In the spreadsheet for this example the certain equivalent is calculated using the approximation (I.6.23) with this value for and with the moments for each portfolio shown in Table I.6.3.

Introduction to Portfolio Theory 237 Table I.6.3 Returns characteristics for two portfolios Portfolio Mean A B 10% 15% Standard deviation Skewness Excess kurtosis −05 −075 2.5 1.5 12% 20% Solution (i) The absolute risk aversion coefficient, as a proportion of the amount invested, is = $1000000 = 5 $200000 In the spreadsheet for this example the certain equivalent is calculated using the approximation (I.6.23) with this value for and with the moments for each portfolio shown in Table I.6.3. Portfolio A has a certain equivalent of 57,700 and portfolio B has a certain equivalent of 12,500, hence portfolio A is preferred. (ii) If the risk tolerance were 400,000 instead of 200,000 then would be only 2.5 and portfolio B would be the preferred investment, with a certain equivalent of 92,188 compared with 80,763 for portfolio A. Hence, portfolio B is more attractive to a less risk averse investor. (iii) When the risk tolerance is small, i.e. the investor is very risk averse, becomes very large and then both portfolios are considered too risky. In fact, if the risk tolerance is only 100,000 then = 10 and the approximation (I.6.23) gives a negative certain equivalent for both investments. Portfolio A has a certain equivalent of − 8,000 and portfolio B has a certain equivalent of − 250,000 relative to an investment of 1 million.


pages: 77 words: 18,414

How to Kick Ass on Wall Street by Andy Kessler

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Andy Kessler, Bernie Madoff, buttonwood tree, call centre, collateralized debt obligation, family office, fixed income, hiring and firing, invention of the wheel, invisible hand, London Whale, margin call, NetJets, Nick Leeson, pets.com, risk tolerance, Silicon Valley, sovereign wealth fund, time value of money, too big to fail, value at risk

Companies are willing to sell these shares to accelerate their business plans, build a new factory, hire 1000 new programmers, whatever. Again, risk is matched with risk tolerance. The buyer of the shares takes on the risk of future profits in exchange for their hard earned capital. It’s a decent deal, hopefully better than the short term interest rate a bank pays – a less risky return. Company shares trade every day, meaning individuals or funds of individuals can raise or lower their risk tolerance by owning shares of future profits in different industries. Getting a little old and not feeling so risky? You might buy shares in Kraft because everyone eats processed cheese. Maybe you have a higher risk tolerance? You buy shares of the future profits of Social Solar Mobility Nanoparticle Networks, hoping it becomes the next big thing.

HOW WALL STREET IS REALLY SUPPOSED TO WORK This is a little bonus (don’t roll your eyes) on the future of Wall Street. Cocktail party conversation stuff. Enjoy: It’s easy to forget how Wall Street and banks and finance are really supposed to work. Home loans and stock trading and IPOs all exist to serve the economy, it’s ALL about the best way of allocating capital, by matching risk with risk tolerance. The rest is just expensive noise. Credit crises and panics happen. Capital gets misallocated. Markets aren’t all knowing. Banks make bad loans. All the time. It used to happen more often, but the Federal Reserve and the FDIC now smooth out these cycles, often pushing problems down the road until they blow up into a full blown panic. Let’s go back to basics. Economies grow via savings, taking the profits going back to the invention of the wheel (or maybe the sale of that Eden apple) and reinvesting it in more and more productive businesses.

So banks found that longer term profit center of their own, lending you the money to buy a home, or a business the money to buy equipment, in exchange for monthly payments, a piece of the human profits you create or a piece of business profits. A pretty fair bargain – the bank takes on the risk of owning these fixed assets (if you fail to make payments) in exchange for a piece of your output. Risk tolerances are matched. Workers lower their take in exchange for ownership of a fixed asset they don’t really own outright. In fact, it’s a societal bargain as well. You gotta keep working. As Popeye’s pal Whimpie said, I’ll gladly pay you Tuesday for a hamburger today, but it meant Whimpie had to work the rest of the week to make enough money to pay off the burger if he ever wanted another one. Wall Street and investment banks are just banks for business profits instead of business assets.


pages: 317 words: 106,130

The New Science of Asset Allocation: Risk Management in a Multi-Asset World by Thomas Schneeweis, Garry B. Crowder, Hossein Kazemi

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asset allocation, backtesting, Bernie Madoff, Black Swan, capital asset pricing model, collateralized debt obligation, commodity trading advisor, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, fixed income, high net worth, implied volatility, index fund, interest rate swap, invisible hand, market microstructure, merger arbitrage, moral hazard, passive investing, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, statistical model, systematic trading, technology bubble, the market place, Thomas Kuhn: the structure of scientific revolutions, transaction costs, value at risk, yield curve

SAMPLE ALLOCATIONS The decision that drives the asset allocation process is the underlying risk tolerance of the investor. As discussed in Chapter 4, an investor’s risk tolerance may cover a range of desired risk exposures.2 Typically those ranges have included conservative, moderate, and aggressive risk based portfolios. Within each of these risk tolerance classifications, investors may decide to invest primarily in traditional security investments or they may decide to place additional investments in the alternative investment area without dramatically changing volatility characteristics. These portfolios will reflect an investor’s characteristics such as assets, liabilities, time horizon, tax status, and risk tolerance. It is fully expected that increased investment in private equity and hedge funds offer financial consultants the investment products required to provide their clients unique returns that are not available through traditional stocks and bonds; and, just as important, provide financial consultants with a set of assets that enable them to show their unique educational role.

This step begins by a description of the investor’s financial condition (assets, liabilities, financial goals, taxes, etc.) and then proceeds with an estimation of the client’s risk capacity and risk tolerance. 3. Optimal asset mix. In this final stage the above information is employed to develop an investment policy statement and to recommend a strategic optimal asset mix. If alternative investments such as private equity and hedge funds are to be included in an investor’s optimal portfolio allocation, investors need to determine: ■ ■ ■ If alternative investments such as private equity and hedge funds represent a distinct asset class and therefore should be included in the analysis taken place in Step 1. If individuals’ risk tolerance makes a compelling case for the inclusion of alternative investments in the optimal asset mix as determined from Step 2. If, as discussed in Step 3, an asset allocation process that includes investment in alternative assets fits the investment policy guidelines and presents a strategic asset mix of traditional and alternative investments that is consistent with investment policy.

For many portfolios, it is necessary to back into the asset allocation decision by first determining a reasonable set of investment vehicles with the desired liquidity and return characteristics. For most, xvi PREFACE traditional asset allocation remains the simple choice of mixing various asset classes to provide a mix of assets that offers increased expected return for a particular level of risk tolerance. However, as discussed previously there is no one definition of risk. Before risk can be managed, the fundamental risks impacting a particular investor must be understood. Chapter 9 reviews some of the major risks facing an investor as well as some common methods of managing them. Finally, we provide several examples of how simple approaches to risk management based on futures markets, options markets, and other basic forms of dynamic asset allocation can fundamentally transform the risk exposure of various investment vehicles.


pages: 335 words: 94,657

The Bogleheads' Guide to Investing by Taylor Larimore, Michael Leboeuf, Mel Lindauer

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asset allocation, buy low sell high, corporate governance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, estate planning, financial independence, financial innovation, high net worth, index fund, late fees, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, market bubble, mental accounting, passive investing, random walk, risk tolerance, risk/return, Sharpe ratio, statistical model, transaction costs, Vanguard fund, yield curve

Over a 70-year period from 1935 to 2004, we can clearly see that an investor in stocks for only one year could have lost 43 percent. However, the most unlucky investor who stayed in stocks for 10 years would have only lost 1 percent. Stocks are desirable as part of a portfolio for longterm goals due to their higher expected return. What Is Your Risk Tolerance? The first thing to do when developing an allocation is to come up with a risk profile. -Errold E Moody Knowing your risk tolerance is a very important aspect of investing and one that the academics have studied extensively. Their experiments prove that most investors are more fearful of a loss than they are happy with a gain. We all know people who are afraid of investing in the stock market because they know they might lose money. Risk-averse savers keep billions of dollars in CDs and bank savings accounts, despite their low yields.

Risk-averse savers keep billions of dollars in CDs and bank savings accounts, despite their low yields. At the other extreme, we know of investors like Donald Trump who think nothing of investing hundreds of millions of dollars in speculative investments-and are seemingly unworried even when bankruptcy looms. Most of us have a risk tolerance that lies somewhere between these extremes. In order to help determine if your portfolio is suitable for your risk tolerance, you need to be brutally honest with yourself as you try to answer the question, "Will I sell during the next bear market?" Here are some stats that might help you answer that question. On March 10, 2000, the Nasdaq Composite Index reached an alltime closing high of 5,049. Thirty-two months later, on October 9, 2002, it was down to 1,224-more than a 75 percent loss for investors who sold at that time.

Over time, the longer-term bonds become intermediate-term bonds, the intermediate-term bonds become short-term bonds, and the short-term bonds eventually mature and are replaced with new bonds. Even though bond funds don't have a maturity date, they do have a measure to help bond fund investors determine if a particular bond fund might be appropriate for them, considering their time horizon and risk tolerance level. The term for that measure is duration. Duration is stated in whole and partial years, such as 4.3 years. Most nontechnical bond and bond fund investors simply use the duration figure to predict a bond or bond fund's price volatility in a rising or falling interest rate environment. The higher the duration figure, the more volatile the bond or bond fund would be in a changing interest rate environment.


pages: 300 words: 77,787

Investing Demystified: How to Invest Without Speculation and Sleepless Nights by Lars Kroijer

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Andrei Shleifer, asset allocation, asset-backed security, Bernie Madoff, bitcoin, Black Swan, BRICs, Carmen Reinhart, cleantech, compound rate of return, credit crunch, diversification, diversified portfolio, equity premium, estate planning, fixed income, high net worth, implied volatility, index fund, invisible hand, Kenneth Rogoff, market bubble, passive investing, pattern recognition, prediction markets, risk tolerance, risk/return, Robert Shiller, Robert Shiller, sovereign wealth fund, too big to fail, transaction costs, Vanguard fund, yield curve, zero-coupon bond

Since the time horizon for those descendants can be much longer term, the portfolio could well include some equities and a generally riskier profile than if it was just for the retirees. It really does depend on your circumstances Like most things in investing, allocations are highly subject to individual circumstances and risk tolerance. Figure 10.4 shows how an investor’s allocations may change over his or her life, ignoring the complication of risky government and corporate bonds in the rational portfolio. Figure 10.4 Stages of life: moving from equities as you age Risk surveys As discussed above, getting a handle on your risk tolerances is not only critical in investment management, but also a very individual thing. In my view, far too often investors rely on their gut feelings in deciding on the risk levels in their portfolios, or are guilty of what some call ‘recency’ where we over-emphasise recent events in planning for the future.

You find them at most banks, insurance companies, asset management firms or your local regulator. As suggested, they are meant to give you an idea about your risk tolerances, often via stress tests, but in my view risk surveys often leave a lot to be desired. Risk surveys that I have completed are too simplistic to give a really detailed view of your risk profile, often because they don’t ask enough questions about your specific situation. Sometimes I find that the surveys are a prelude to someone trying to sell me a specific ‘tailor-made’ product (read: expensive), instead of objectively trying to help me understand my risk tolerance. In addition, risk surveys often fail to properly incorporate all my other assets and liabilities, including seemingly odd ones like education, inheritance, future tuition for children, or other critical things like what stage of life I’m at regarding career or retirement.

Table 3.1 The rational portfolio at different risk preferences So someone with £100 to invest and a medium ‘C’ risk profile could do as follows: Allocation Investment £33 UK government bond tracker with maturity matching investor’s time horizon £50 World equity index tracker product £7 Diversified return generating government bonds of varying maturities, countries and currencies, rated sub-AA £10 Broad range of corporate bonds of varying maturity, credit risk, currency, issuer and geography. I will discuss how I came up with the allocations above. Whilst the allocations are not an exact science and therefore do not have to be implemented in exactly the proportions illustrated, you would do very well if you implement your portfolio in a similar manner. Of course our risk tolerances differ. Let’s say that we have $100 now and need $110 in 10 years’ time, and that we invest in the world equity markets where we expect real returns of about 5% a year. If we assume that performance every year will in fact be 5% we know that in 10 years our $100 will have become $162 and be far in excess of what we need. But that is not the whole story. Since the equity markets are inherently risky, what can we say about the probability that we don’t reach $110?

The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk by William J. Bernstein

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asset allocation, backtesting, capital asset pricing model, computer age, correlation coefficient, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, fixed income, index arbitrage, index fund, Long Term Capital Management, p-value, passive investing, prediction markets, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, South Sea Bubble, the scientific method, time value of money, transaction costs, Vanguard fund, Yogi Berra, zero-coupon bond

This is essentially a recapitulation of the Chapter 5 discussion, except that I’ve changed the order of the steps: 1. Determine your basic allocation between stocks and bonds. First, answer the question, “What is the biggest annual portfolio loss I am willing to tolerate in order to get the highest returns?” Table 8-1 summarizes the process of determining your risk tolerance. In previous versions of the book, I allowed the most risk-tolerant investors 100% equity exposure. At the present time, however, it appears that expected stock and bond returns going forward may not be all that different, and a dollop of bonds is recommended for all investors. The percentage stock recommendations in Table 8-1 will need to be revised downward depending on your time horizon. Your 143 144 The Intelligent Asset Allocator Table 8-1.

Acquire an appreciation of the nature of and fundamental relationship between risk and reward in the financial markets. 3. Learn about the risk/reward characteristics of various specific investment types. 4. Appreciate that diversified portfolios behave very differently than the individual assets in them, in much the same way that a cake tastes different from shortening, flour, butter, and sugar. This is called portfolio theory and is critical to your future success. 5. Estimate how much risk you can tolerate; then learn how to use portfolio theory to construct a portfolio tailored to produce the most return for that amount of risk. 6. At this point you are finally ready to purchase individual stocks, bonds, and mutual funds. If you have succeeded in the above tasks, this is by far the easiest step. The Intelligent Asset Allocator will take you through the above steps chapter by chapter on your journey to a coherent and effective lifetime investment strategy.

Recall from Chapter 4 that international small stocks have lagged the S&P 500 by 19% per year since 1990, even though their performance over the past 30 years has been outstanding. In fact, the more exotic asset classes you add to your mix, the higher your tracking error will be. Remember, that tracking error does not mean lower returns, it just means that your portfolio will behave very differently from everyone else’s, and that it will often temporarily underperform everybody else’s. Risk Tolerance The third step in the asset allocation process is by far the easiest. You have already done the heavy lifting—deciding what stock asset classes to use, 80 The Intelligent Asset Allocator and in approximately what proportion to use them. Now all you have to determine is the overall mix of stocks and bonds. In the first versions of this book, I recommended that the most aggressive investors might consider a 100% equity portfolio.


pages: 357 words: 91,331

I Will Teach You To Be Rich by Sethi, Ramit

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Albert Einstein, asset allocation, buy low sell high, diversification, diversified portfolio, index fund, late fees, mortgage debt, mortgage tax deduction, prediction markets, random walk, risk tolerance, Robert Shiller, Robert Shiller, shareholder value, Silicon Valley, Vanguard fund

Moves like this don’t bother me as much as they might bother other people (my wife, for example) because my risk tolerance is high. I have twenty or thirty years to go before retirement. That’s two or three decades to recover from any further market drops. Risk and reward go hand in hand. The historically high returns of the stock market are impossible without risk; anyone who tells you otherwise is lying. But not everyone can stomach having all of their investments in stocks and mutual funds. If your risk tolerance is low (if you’re scared of bears), or you’re approaching retirement, it’s best to keep your money someplace safe, such as bond funds or high-yield savings accounts. I keep cash equal to a few months of expenses in savings. I have a friend who is far less risk-tolerant than I am who keeps an entire year of expenses in savings.

LIFECYCLE FUNDS AUTOMATICALLY ADJUST AS YOU GET OLDER * * * Here’s a comparison of two popular lifecycle funds. These funds target roughly the same age—someone in his or her twenties—and assume retirement at age sixty-five. You should pay special attention to the minimum initial investment (it matters if you don’t have a lot of money lying around) and the asset allocation, which will help you determine which fund most suits your risk tolerance. Remember, these are only two example funds; you can choose among many lifecycle funds offered by companies like the ones I list on page 187. The major benefit to a lifecycle fund is that you set it and forget it. You just keep sending money and your fund will handle the allocation, trading, and maintenance, automatically diversifying for you. If you invest in a lifecycle fund, you could literally spend minutes per year on your investments.

One advantage is that the fund requires only a $1,000 minimum to invest if you’re doing it within a Roth IRA. Other popular companies with lifecycle funds include Schwab, Fidelity, and TIAA-CREF. Check their websites or call them up (see page 87 for some contact information). You want to look for lifecycle funds, which may also be called target-date retirement funds. Note: Those target dates are just a suggestion. You can choose any lifecycle fund, depending on your age and risk tolerance. So if you’re twenty-five and pretty risk averse, you can pick a fund designed for someone older, which will give you a more conservative asset allocation. BUYING INTO YOUR LIFECYCLE FUND Now that you’ve identified a lifecycle fund to invest in, actually buying it is an easy process. Log in to your Roth IRA (which you opened in Chapter 3). Your login information should be handy if you followed my tip on page 88.


pages: 407 words: 114,478

The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein

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asset allocation, Bretton Woods, British Empire, buy low sell high, carried interest, corporate governance, cuban missile crisis, Daniel Kahneman / Amos Tversky, Dava Sobel, diversification, diversified portfolio, Edmond Halley, equity premium, estate planning, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, German hyperinflation, high net worth, hindsight bias, Hyman Minsky, index fund, invention of the telegraph, Isaac Newton, John Harrison: Longitude, Long Term Capital Management, loss aversion, market bubble, mental accounting, mortgage debt, new economy, pattern recognition, quantitative easing, railway mania, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, South Sea Bubble, transaction costs, Vanguard fund, yield curve

Table 4-1. 1901–2000, 100-Year Annualized Return versus 1973–1974 Bear Market Return The data in Table 4-1 and the plot in Figure 4-6 vividly portray the tradeoff between risk and return. The key point is this: the choice between stocks and bonds is not an either/or problem. Instead, the vital first step in portfolio strategy is to assess your risk tolerance. This will, in turn, determine your overall balance between risky and riskless assets—that is, between stocks and short-term bonds and bills. Many investors start at the opposite end of the problem—by deciding upon the amount of return they require to meet their retirement, educational, life style, or housing goals. This is a mistake. If your portfolio risk exceeds your tolerance for loss, there is a high likelihood that you will abandon your plan when the going gets rough. That is not to say that your return requirements are immaterial. For example, if you have saved a large amount for retirement and do not plan to leave a large estate for your heirs or to charity, you may require a very low return to meet your ongoing financial needs.

Now all Ted has to do is to determine his overall stock/bond mix. First he takes a look at Figures 4-1 through 4-5. Being an analytical type, he comes up with a table that relates his risk tolerance to his overall stock allocation. This is shown in Table 13-7. Take a good look at it. Realize that this is only a starting point. Have you ever actually lost 25% of your assets? It is one thing to think about it, and quite another to actually have it happen to you. (Remember the aircraft-simulator crash versus real-aircraft crash analogy mentioned earlier.) The classic beginner’s mistake is to overestimate his risk tolerance, then decamp forever from stocks when the inevitable loss hurts more than he had ever expected. When in doubt, tone down your portfolio’s risks by shaving your exposure to stocks.

But you are also minimizing the chances of impoverishing yourself and the ones you love. CHAPTER 13 SUMMARY 1. The major stock asset classes you should own are domestic, foreign, and REITs. You may further break the domestic portion into the “four corners”: large market, small market, large value, and small value. 2. Your overall stock/bond allocation is determined by your time horizon, risk tolerance, and tax structure. Since stock and bond returns may be quite similar in the future, you should hold at least 20% in bonds, no matter how risk tolerant you think you are. 3. The stock and bond asset classes you employ are primarily dictated by the percentage of your portfolio that is tax-sheltered. 4. The easiest asset structures to design are those where more than half of assets are tax-sheltered. 5. If you have less than 50% of your assets in sheltered vehicles, you should place value stocks and REITs in them.


pages: 337 words: 89,075

Understanding Asset Allocation: An Intuitive Approach to Maximizing Your Portfolio by Victor A. Canto

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accounting loophole / creative accounting, airline deregulation, Andrei Shleifer, asset allocation, Bretton Woods, buy low sell high, capital asset pricing model, commodity trading advisor, corporate governance, discounted cash flows, diversification, diversified portfolio, fixed income, frictionless, high net worth, index fund, inflation targeting, invisible hand, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market bubble, merger arbitrage, new economy, passive investing, price mechanism, purchasing power parity, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, shareholder value, Sharpe ratio, short selling, statistical arbitrage, the market place, transaction costs, Y2K, yield curve

This outline, combined with the forecast of the economic indicators, suggests the portfolio tilts needed to take advantage of the foreseen economic environment. 64 UNDERSTANDING ASSET ALLOCATION Economic Drivers Asset Choices Rising Inflation Rate Real Interest Rates Inflation, Taxes, and Regulation Inflation Induced Tax Bracket Creep Foreign Exchange Value of the Dollar T-Bills Falling T-Bonds Rising Equities Falling T-Bonds Rising Small-Cap Falling Large-Cap Rising Value Falling Growth Rising Domestic Falling Foreign Figure 3.4 Economic drivers and asset choices. The final element of the cyclical strategy is to forecast the foreign-exchange market. The conviction of this forecast can then be used to tilt a portfolio in favor of the asset class favored by the exchange-rate forecast. How much of the potential gain is captured by this strategy depends on the quality of the forecast and the risk tolerance of the investor. The greater the risk aversion, the less sensitive the tilt around the long-run allocation. This approach suggests a simple way for investors to take advantage of changing conditions over business and economic cycles. Chapter 3 Thinking in Cycles 65 This page intentionally left blank 4 TAX TIPS 67 T he corporate story in recent years has been an ugly one. But most black ink dedicated to corporate accounting scandals, questionable capital structures, distorted executive-compensation packages, and rising equity risk premiums has failed to pinpoint an important source of the ugliness: Each undesirable episode was in part influenced by the tax changes that took place over the last two decades.

Allocations Based on the Last 30 Years Traditionally, developing an SAA is a two-step process, and a perilous one for the individual investor. The first step uses the asset classes’ historical returns and the variance–covariance matrix to build a combination of the various asset classes that leads one to the efficient frontier. This step also leads an investor to the point where maximum expected returns are reached for a determined risk level. The second step determines risk tolerance so an investor can choose the risk/return combination best suiting his or her preferences. I have two major objections to this process as it is currently practiced. The first objection is simply empirical: How long of a historical sample does one need to determine long-run historical returns and the variance–covariance matrix? In earlier chapters, I used traditional asset-allocation tools to decide whether individual asset classes—Treasury bonds (T-bonds), small-caps, large-caps, value stocks, growth stocks, and domestic/international stocks—would be included on the efficient frontier and thus be potentially included in an investor portfolio.

This is a daunting task for an investor, let alone an individual financial advisor. A simple way, however, exists to approach and solve the problem. The efficient market theory tells us that, in an idealized situation, the market portfolio is on the efficient frontier. If this is the case, then all asset classes should be included on the efficient frontier and, therefore, in an economy-wide (or aggregate) SAA portfolio. As it is true individuals differ regarding their risk-tolerances and investment preferences, it follows their individual asset-allocation plans differ from those of the aggregate economy. Investors, however, cannot collectively avoid economy-wide constraints. Ultimately, a weighted average of individual asset allocations must add up to the market allocation. So, the market allocation is a good place to start building an SAA program. One can argue the market allocation is the relevant allocation for an infinite number of foundations and trust funds.


pages: 263 words: 89,368

925 Ideas to Help You Save Money, Get Out of Debt and Retire a Millionaire So You Can Leave Your Mark on the World by Devin D. Thorpe

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asset allocation, call centre, diversification, estate planning, Home mortgage interest deduction, index fund, knowledge economy, mortgage tax deduction, payday loans, random walk, risk tolerance, Skype, Steve Jobs, transaction costs, women in the workforce

These funds have virtually no credit risk and relatively modest interest rate risk, so should provide consistent, though modest returns. Choose a fifth fund to match your age or appetite. You can now choose a fifth fund to skew your portfolio in the direction that makes you most comfortable. If you are risk tolerant and sleep well knowing your funds go up and down in value, you may want to invest in a risky fund to help increase the yield in your portfolio. There are a variety of specialty funds that make concentrated investments in industries, regions and countries. These funds often beat the market one year and trail it dramatically the next. On the other hand, if you are not risk tolerant or are closer to retirement, you may want to make your final fund a short term government bond fund that invests in bonds with maturities of less than four years so there is very little interest rate risk and virtually no credit risk.

Bonds have less risk, but still have risk loss of principle and the income on bond funds varies significantly from year to year. Cash features ultra-low risk and correspondingly low returns. The goal of asset allocation is to match your risk tolerance, return on investment goals, and investment objectives to your portfolio. For short-term objectives, investing only in cash or in cash and bonds would generally make sense. For long-term objectives, like retirement, investing in a combination of all three would be considered wise. People in their twenties investing for retirement have the flexibility, if they are risk tolerant enough, to be invested 100% in equities. As people age, retirement gets closer and the pain of a major setback in investment returns looms larger so they generally shift the allocation to include more bonds and even a bit of cash.

Such bonds have no credit risk, that is no risk of not being paid on schedule, but as interest rates change, the value of the bonds will fluctuate. Each of these fund categories would make a good first fund for your retirement savings. They offer high expected returns—compared to what you can earn in a bank account. They are listed in order from most risky to least risky. You can decide which of these three best represents your risk tolerance based on your own situation. Once you’ve decided upon a category, you’ll want to choose an individual fund based primarily on the expenses. Your broker should provide you with a list of mutual funds you can purchase with no transaction fees. You’ll also want to choose a fund that doesn’t charge a “load” or upfront fee. You’ll also want to avoid marketing and distribution fees called 12b-1 fees.


pages: 327 words: 91,351

Traders at Work: How the World's Most Successful Traders Make Their Living in the Markets by Tim Bourquin, Nicholas Mango

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algorithmic trading, automated trading system, backtesting, commodity trading advisor, Credit Default Swap, Elliott wave, fixed income, Long Term Capital Management, paper trading, pattern recognition, prediction markets, risk tolerance, Small Order Execution System, statistical arbitrage, The Wisdom of Crowds, transaction costs

What I really needed to do was hone my technical skills in reading charts. I started doing that “quest” for the Holy Grail, just like every trader does at some point in their trading career. We all begin looking for the magic setup or a magic methodology that will work in all markets and all time frames. Of course, it doesn’t exist, but you still have to find a strategy and method that fits your personal style and risk tolerance. I searched high and low for a good couple of years before I found my current methodology. I really had to work hard to make the switch from trading momentum to trading on a more technical level based on charts. The point is you really need to get more technical to trade FX, because it’s so much more of a chess game than a boxing match with an opponent [the specialist], which is what day trading equities was.

Bourquin: Let’s now talk about sizing and how you determine your position size when using options. Foster: It depends on allocation, and for my account versus some of my client accounts, I might be more aggressive. I might use more small caps if I think small caps are looking strong, or I might use a heavier allocation towards small caps because I think I am going to get better performance there than I would with the Dow. It also depends on my risk tolerance at the time. I’m usually pretty aggressive in my trades, but I do factor in current or upcoming events in my personal life and may become more hesitant to take risk under certain conditions. Bourquin: What’s an average option contract size for a trade in your personal account? Foster: I typically only use two contracts at a time, and while I might use multiple contracts in a week, in any one day I only use two contracts at once.

Not knowing, or simply guessing at, where these price points will be after you have entered a trade can lead to indecision or price targets outside of the average range of the security you are trading. Why set an arbitrary profit target of three points when the average range of that market is only two points? Furthermore, wealthy traders set position sizes and stop losses that are almost always a function of their risk tolerance for any given trade. For example, if the maximum risk on any one trade is 2 percent of their trading account, they will calculate both the number of shares they will trade (based on the price of shares) and a reasonable stop loss before they place the trade. I rarely talk with a wealthy trader who says their position size is 1,000 shares. They usually tell me it depends entirely on what security they are trading.


pages: 1,088 words: 228,743

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

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Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, New Journalism, oil shock, p-value, passive investing, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond

Either way, time-varying opportunities may not justify active trading for an investor who is similar to the market. Buying opportunities tend to be greater in bad times just when the risk or risk aversion is commensurately higher. Contrarian market timing is not for everyone (and cannot be—or contrarian investors would have no one to trade with). Investors who differ from the market by having a longer investment horizon and greater risk tolerance than most investors may be natural risky asset buyers during bad times when valuations are attractive. (This last statement is based more on strong intuition than on existing theoretical models; see note 5 in Chapter 28.) Time-varying risk premia can generate a “discount rate effect”: changes in the market’s required returns cause opposite-signed moves in realized returns. This effect makes extrapolation of past returns doubly dangerous.

In equilibrium, the expected total cost of renting and owning a house should be equal over the life of the house, after accounting for the above features. Thus, higher price-to-rent ratios may reflect lower financing costs or changes in any of the features listed above. Such comparisons are one way to assess how much of the housing market rally was based on fundamentals and how much was irrational, perhaps reflecting extrapolative expectations and the naive belief that house prices cannot fall. General liquidity, high risk tolerance (complacency), securitization innovations in mortgage markets, and lax lending standards also contributed. Wallison (2009) has also blamed government policy intended at expanding the proportion of homeowners, but his argument explains only the housing boom in the U.S.—not the rest of the world. Rajan (2010) argues that U.S. politicians promoted home ownership and, especially, abundant mortgage financing among low-income households as a palliative against stagnating real wages and rising income inequality.

These studies identify expected returns by the ability of some countercyclical indicator (such as yield curve steepness or consumption–wealth ratio) to predict near-term returns—and assume that fitted realized returns in a regression are the expected returns of a rational market. Based on this logic, rational investors may foresee low expected returns near a cyclical peak and accept these as fair, thanks to their higher risk tolerance amidst abundant wealth. However, even if predictability regressions capture objectively feasible near-term returns, survey evidence raises doubts about whether most investors subjectively expect such countercyclic patterns. Individual investor surveys, especially, suggest that at the end of expansions (near cyclical peaks), optimistic investors have subjectively high expected returns or a high risk appetite, which boosts today’s prices for risky assets and reduces their prospective feasible returns.


pages: 264 words: 115,489

Take the money and run: sovereign wealth funds and the demise of American prosperity by Eric Curt Anderson

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asset allocation, banking crisis, Bretton Woods, business continuity plan, business intelligence, business process, collective bargaining, corporate governance, credit crunch, currency manipulation / currency intervention, currency peg, diversified portfolio, floating exchange rates, housing crisis, index fund, Kenneth Rogoff, open economy, passive investing, profit maximization, profit motive, random walk, reserve currency, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, sovereign wealth fund, the market place, The Wealth of Nations by Adam Smith, too big to fail, Vanguard fund

A Morgan Stanley estimate published in June 2007 largely came to the same conclusion, noting that “asset prices should depend on the willingness of investors to take risks.” As such, Morgan Stanley had argued, “the likely growth of sovereign wealth funds—and the substantially higher risk tolerance of those who will be making their asset allocation decisions—is likely to be rapid enough that it will have a material impact on the average degree of risk tolerance of investors across the globe.”139 The ultimate result? “As sovereign wealth funds grow . . . in importance, the overall global degree of risk tolerance in financial markets rises. This reduces somewhat the attractiveness of relatively safe assets— ‘bonds’—and increases the attractiveness of riskier, higher-yielding assets— ‘equities.’”140 This is a rosy scenario for share issuers and holders, but bad news for the U.S.

Treasury, a sovereign wealth fund is “a government investment vehicle which is funded by foreign reserve assets, and which manages those assets separately from the official reserves of the monetary authorities (the central bank and reserve-related functions of a finance ministry or national treasury office).”8 Efforts to refine this definition have included highlighting key traits associated with a sovereign wealth fund such as the investment vehicles’ high foreign currency exposure, lack of explicit liabilities, high risk tolerances, and long investment horizons.9 The bottom line: A sovereign wealth fund is a pool of public money that is under governmental supervision and can be invested in a manner more commonly associated with privately held capital. (Note: I do not rule out the possibility that a sovereign wealth fund ultimately has liabilities such as bondholders in the case of the China Investment Corporation, or future pensioners, as with Norway’s Government Pension Fund.)

Echoing sentiments Stephen Jen expressed during November, in early December 2007 the Journal reported, “because most sovereign wealth funds buy long-term investments, the funds could have a stabilizing influence on world markets, particularly during periods of high volatility and tight credit.” Nevertheless, the newspaper then went on to note that the lack of transparency associated with most sovereign wealth funds’ limited ability to raise risk tolerance in financial markets—because so little “is known about many of the funds’ investment strategies, structures, or holdings.”92 Not surprisingly, the fund managers are aware of this concern. The China Investment Corporation, for instance, has made a concerted effort to assure international observers that Beijing seeks to make the government investment vehicle’s operations largely transparent. This CIC campaign began in earnest in early August 2007, when Chinese authorities publicly announced the names of the fund’s core management team.93 By early September, members of this management team were reassuring reporters and foreign observers that CIC will be “a passive investor . . . most of our money will be [invested] through outsourcing to fund managers instead of . . . direct investment.”94 Staying on message, in mid-November, the new CIC chairman told an international audience in Beijing his organization would act “as a force to stabilize markets as needed.”


pages: 426 words: 115,150

Your Money or Your Life: 9 Steps to Transforming Your Relationship With Money and Achieving Financial Independence: Revised and Updated for the 21st Century by Vicki Robin, Joe Dominguez, Monique Tilford

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asset allocation, Buckminster Fuller, buy low sell high, credit crunch, disintermediation, diversification, diversified portfolio, fiat currency, financial independence, fudge factor, full employment, Gordon Gekko, high net worth, index card, index fund, job satisfaction, Menlo Park, Parkinson's law, passive income, passive investing, profit motive, Ralph Waldo Emerson, Richard Bolles, risk tolerance, Ronald Reagan, Silicon Valley, software patent, strikebreaker, Thorstein Veblen, Vanguard fund, zero-coupon bond

But during times when inflation is high and you’ve made all the adjustments you can and still feel you need more income, you might want to consider taking more risk with your money to increase your chances of a higher return. As an FIer, you don’t want to risk your nest egg. But you are already putting the value of your nest egg at risk if your investment returns don’t at least keep pace with inflation. How exactly do you manage your money to reduce the risks associated with inflation? Risk Tolerance Any financial professional will tell you that it’s important to determine your risk tolerance before making any investments. The spectrum ranges from conservative investors who do not want to risk their capital at all to aggressive ones at the other end of the spectrum who are willing to risk all their capital for the promise of significant returns. Waaaay at the conservative end are those who’d prefer to put their nest egg in the mattress or in a sealed tin buried in the garden (make sure you make a map).

Even that bears some risk; as we said earlier, inflation could eat it even if the moths or worms don’t and your money could be worth less later. Waaaaay at the speculative end you’ll find few FIers because they usually don’t have the stomach for putting their hard-earned nest egg at risk in the stock market. Most FIers probably fall somewhere in the middle. If you’d like to learn more about what your personal investment philosophy might be, type “risk tolerance” in your browser and take one of the many free tests available on the Web. THREE PILLARS OF FINANCIAL INDEPENDENCE: CAPITAL, CUSHION AND CACHE The basic FI investment program has three elements: Capital: The sum that is invested, ultimately producing at least as much income as indicated by the Crossover Point of Chapter 8. Cushion: A cash reserve that is enough to cover your expenses for six months.

◆Duration—the range of maturities available is extensive; you can buy a note or bond that will mature in a few months or one that won’t come due for thirty years. ◆Absolute stability of income over the long run—ideal for FI. Avoids the income fluctuations that would occur with money market funds, rental real estate, etc. Treasury Bonds Treasury bonds are the ideal investment vehicle for FIers with a low risk tolerance because they protect principal, provide a steady stream of income and are relatively easy to understand. In addition, they are exempt from local and state taxes, can be bought and sold almost instantly with minimal handling charges, and are protected by the full faith and trust of the U.S. government. Treasury bonds are the government’s way of borrowing money. A new bond is issued every few months, with maturity dates ten, twenty, and thirty years into the future.


pages: 206 words: 70,924

The Rise of the Quants: Marschak, Sharpe, Black, Scholes and Merton by Colin Read

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Albert Einstein, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, discovery of penicillin, discrete time, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, floating exchange rates, full employment, Henri Poincaré, implied volatility, index fund, Isaac Newton, John von Neumann, Joseph Schumpeter, Long Term Capital Management, Louis Bachelier, margin call, market clearing, martingale, means of production, moral hazard, naked short selling, price stability, principal–agent problem, quantitative trading / quantitative finance, RAND corporation, random walk, risk tolerance, risk/return, Ronald Reagan, shareholder value, Sharpe ratio, short selling, stochastic process, The Chicago School, the scientific method, too big to fail, transaction costs, tulip mania, Works Progress Administration, yield curve

These qualities can be superimposed on the Markowitz bullet and the capital allocation line. Markowitz’s model is most profound if we accept the assumptions that a security can be priced based on its mean historic return and its Expected return Capital allocation line Efficient portfolio frontier Risk-free return Risk Figure 10.1 The capital allocation line 64 The Rise of the Quants Expected return High risk tolerance Capital allocation line Efficient portfolio frontier Low risk tolerance Risk-free return Risk Figure 10.2 Various choices of risk and return along the capital allocation line variance or standard deviation. However, it also acted as a springboard to an equally elegant interpretation from one of Markowitz’s associates, William Forsyth Sharpe. The Sharpe insight By the time William Forsyth Sharpe introduced himself to Markowitz in 1960 at the RAND Corporation, at the behest of a mentor, Fred Weston at UCLA, Modern Portfolio Theory was still a relatively theoretical insight.

The firm’s rejection of their insights elicited the same reaction from Black as any such rejection had had on him since adolescence – it made him believe his hypothesis with even greater fervor. Undaunted, Black began to think more about the optimal investment portfolio that could beat the market. He saw options as one way to adjust investment risk exposure at a given time. This is in contrast to the Samuelson approach, which saw options as a discounting problem to settlement based on an individual investor’s risk tolerance. The former is a market-based approach, while the latter is the economist’s representative agent approach. Black started with the assumption that an option price is simply a function of the underlying stock price and the amount of time remaining until settlement. Rewriting in modern standard notation the warrant denotation that Samuelson had used in 1965, we can express Black’s relationship as C(S,t).

He succeeded in creating a continuous-time dynamic portfolio theory that was much more elegant and general than the discrete versions that others were producing. A month after presenting the paper co-authored with Samuelson to the faculty seminar, he presented his own paper to the Harvard/MIT graduate student seminar. This paper was published the following summer as the other bookend to a paper that Samuelson had written on the life cycle of portfolio risk tolerance. In fact, Merton later admitted that his strategy was to learn the mathematics he needed rather than the economics his professors taught, much like Albert Einstein had done as a graduate physics 144 The Rise of the Quants student. He agreed that this was not the best strategy to secure superior grades. However, the proof is in the pudding. He produced five essays for his PhD thesis, three of which were published by refereed finance and economics journals even before his dissertation team could witness his PhD defense.


pages: 416 words: 118,592

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel

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accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, Bernie Madoff, BRICs, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, mortgage tax deduction, new economy, Own Your Own Home, passive investing, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, The Myth of the Rational Market, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

Domestic stocks: 1926–1970 S&P 500 Index (monthly reinv); 1971–4/22/2005 Dow Jones Wilshire 5000 Index; 4/22/2005 – present MSCI US Broad Market Index. In summary, the timeless lessons of diversification are as powerful today as they were in the past. In Part Four, I will rely on this discussion of portfolio theory to craft appropriate asset allocations for individuals in different age brackets and with different risk tolerances. REAPING REWARD BY INCREASING RISK Theories that are right only 50 percent of the time are less economical than coin-flipping. —George J. Stigler, The Theory of Price AS EVERY READER should know by now, risk has its rewards. Thus, both within academia and on the Street, there has long been a scramble to exploit risk to earn greater returns. That’s what this chapter covers: the creation of analytical tools to measure risk and, with such knowledge, reap greater rewards.

A typical response was that a personal contact, such as a friend or relative, had recommended the purchase. Harrison Hong, Jeffrey Kubik, and Jeremy Stein provided more systematic evidence as to the importance of friends in influencing investors’ decisions. They found that social households—those who interact with their neighbors, or attend church—are substantially more likely to invest in the market than nonsocial households, controlling for wealth, race, education, and risk tolerance. Any investment that has become a topic of widespread conversation is likely to be especially hazardous to your wealth. It was true of gold in the early 1980s and Japanese real estate and stocks in the late 1980s. It was true of Internet-related stocks in the late 1990s and early 2000 and condominiums in California, Nevada, and Florida in the first decade of the 2000s. Invariably, the hottest stocks or funds in one period are the worst performers in the next.

On the other hand, if you are in a low tax bracket and need high current income, you should prefer taxable bonds and high-dividend-paying common stocks so that you don’t have to incur the transactions charges involved in selling off shares periodically to meet income needs. The two steps in this exercise—finding your risk level, and identifying your tax bracket and income needs—seem obvious. But it is incredible how many people go astray by mismatching the types of securities they buy with their risk tolerance and their income and tax needs. The confusion of priorities so often displayed by investors is not unlike that exhibited by a young woman whose saga was recently written up in a London newspaper: RED FACES IN PARK London, Oct. 30 Secret lovers were locked in a midnight embrace when it all happened. Wedged into a tiny two-seater sports car, the near-naked man was suddenly immobilised by a slipped disc, according to a doctor writing in a medical journal here.

Early Retirement Guide: 40 is the new 65 by Manish Thakur

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Airbnb, diversified portfolio, financial independence, index fund, Lyft, passive income, passive investing, risk tolerance, Robert Shiller, Robert Shiller, time value of money, Vanguard fund, Zipcar

If the entirety of your money is in monthly income generating investments, such as rental properties, then the amount invested could vary greatly from this 25x rule. If you're more risk averse and will worry about having enough, you can use a higher multiplier, such as 30, to calculate your required amount. For people who are more tolerant of risk and believe they can easily become employed if their money runs out, the multiplier could be lower, around 20x yearly spending. For less risk tolerant people, this multiplier will be anywhere from 30-50x. Challenges: 1. Based on a quick calculation of your yearly expenses, determine how much money you would need at this moment to become financially independent. 2. Calculate how much you would need to save to reach this number based on what you've already saved. Practical Steps to Early Retirement Now that we've gone through the fundamentals for the why and how of early retirement, well start looking at the practical steps we can take to become free of money and the need to trade our time to obtain more of it.


pages: 503 words: 131,064

Liars and Outliers: How Security Holds Society Together by Bruce Schneier

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airport security, barriers to entry, Berlin Wall, Bernie Madoff, Bernie Sanders, Brian Krebs, Broken windows theory, carried interest, Cass Sunstein, Chelsea Manning, corporate governance, crack epidemic, credit crunch, crowdsourcing, cuban missile crisis, Daniel Kahneman / Amos Tversky, David Graeber, desegregation, don't be evil, Double Irish / Dutch Sandwich, Douglas Hofstadter, experimental economics, Fall of the Berlin Wall, financial deregulation, George Akerlof, hydraulic fracturing, impulse control, income inequality, invention of agriculture, invention of gunpowder, iterative process, Jean Tirole, John Nash: game theory, joint-stock company, Julian Assange, meta analysis, meta-analysis, microcredit, moral hazard, mutually assured destruction, Nate Silver, Network effects, Nick Leeson, offshore financial centre, patent troll, phenotype, pre–internet, principal–agent problem, prisoner's dilemma, profit maximization, profit motive, race to the bottom, Ralph Waldo Emerson, RAND corporation, rent-seeking, RFID, Richard Thaler, risk tolerance, Ronald Coase, security theater, shareholder value, slashdot, statistical model, Steven Pinker, Stuxnet, technological singularity, The Market for Lemons, The Nature of the Firm, The Spirit Level, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, too big to fail, traffic fines, transaction costs, ultimatum game, UNCLOS, union organizing, Vernor Vinge, WikiLeaks, World Values Survey, Y2K

For these and other reasons, we exaggerate the risk and end up spending much too much on security to mitigate it. Another example is computer crime. It's pedestrian, common, slowly evolving, affecting others, increasingly familiar, and (at least by techies) well-understood. So it makes sense that we understate the risks and underfund security. There are cultural biases to risk as well. According to one study conducted in 23 countries, people have a higher risk tolerance in cultures that avoid uncertainty or are individualistic, and a lower risk tolerance in cultures that are egalitarian and harmonious. Also—and this is particularly interesting—the wealthier a country is, the lower its citizens' tolerance for risk. Along similar lines, the greater the income inequality a society has, the less trusting its citizens are. Creating a dilemma that encourages deception. Think back to the two prisoners for a minute.

Sometimes we need the dispassionate lens of history to judge famous defectors like Oliver North, Oskar Schindler, and Vladimir Lenin. Part I The Science of Trust Chapter 2 A Natural History of Security Our exploration of trust is going to start and end with security, because security is what you need when you don't have any trust and—as we'll see—security is ultimately how we induce trust in society. It's what brings risk down to tolerable levels, allowing trust to fill in the remaining gaps. You can learn a lot about security from watching the natural world. Lions seeking to protect their turf will raise their voices in a “territorial chorus,” their cooperation reducing the risk of encroachment by other predators for the local food supply. When hornworms start eating a particular species of sagebrush, the plant responds by emitting a molecule that warns any wild tobacco plants growing nearby that hornworms are around.

(Large, long-term risks like nuclear weapons, genetic engineering, and global warming are much harder for us to comprehend, and we tend to minimize them as a result.) Today, societal scale continues to grow as global trade increases, the world's economies link up, global interdependencies multiply, and international legal bodies gain more power. On a more personal level, the Internet continues to bring distant people closer. Our risk tolerance has become so low that we have a fetish for eliminating—or at least pretending to eliminate—as much risk as possible from our lives. Let's get back to societal pressures as a series of knobs. Technology is continuously improving, making new things possible and existing things easier, cheaper, better, or more reliable. But these same technological advances result in the knobs being twiddled in unpredictable ways.


pages: 470 words: 144,455

Secrets and Lies: Digital Security in a Networked World by Bruce Schneier

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Ayatollah Khomeini, barriers to entry, business process, butterfly effect, cashless society, Columbine, defense in depth, double entry bookkeeping, fault tolerance, game design, IFF: identification friend or foe, John von Neumann, knapsack problem, mutually assured destruction, pez dispenser, pirate software, profit motive, Richard Feynman, Richard Feynman, risk tolerance, Silicon Valley, Simon Singh, slashdot, statistical model, Steve Ballmer, Steven Levy, the payments system, Y2K, Yogi Berra

In terms of risk, organized crime is what you get when you combine lone criminals with a lot of money and organization. These guys know that you have to spend money to make money, and are willing to invest in profitable attacks against a financial system. They have minimal expertise, but can purchase it. They have minimal access, but they can purchase it. They often have a higher risk tolerance than lone criminals; the pecking order of the crime syndicate often forces those in the lower ranks to take greater risks, and the protection afforded by the syndicate makes the risks more tolerable. POLICE You can think of the police as kind of like a national intelligence organization, except that they are less well funded, less technically savvy, and focused on crimefighting. Understand, though, that depending on how benevolent the country is and whether or not they hold occasional democratic elections, “crimefighting” could cover a whole lot of things not normally associated with law enforcement.

An insider can use the system’s own resources against itself. In extreme cases the insider might have considerable expertise, especially if he was involved in the design of the systems he is now attacking. Revenge, financial gain, institutional change, or even publicity can motivate insiders. They generally also fit into another of the categories: a hacker, a lone criminal, or a national intelligence agent. Malicious insiders can have a risk tolerance ranging from low to high, depending on whether they are motivated by a “higher purpose” or simple greed. Of course, insider attacks aren’t new, and the problem is bigger than cyberspace. If the e-mail system hadn’t been there, the Schwab employees might have used the telephone system, or fax machines, or maybe even paper mail. INDUSTRIAL ESPIONAGE Business is war. Well, it’s kind of like war, but it has referees.

Industrial espionage can be well-funded; an amoral but rational company will devote enough resources toward industrial espionage to achieve an acceptable return on investment. Even if stealing a rival’s technology costs you half a million dollars, it could be one-tenth the cost of developing the technology yourself. (Ever wonder why the Russian Space Shuttle looks a whole lot like the U.S. Space Shuttle?) This kind of adversary has a medium risk tolerance because a company’s reputation (an intangible but valuable item) will be damaged considerably if it is caught spying on the competition—but desperate times can bring desperate measures. PRESS Think of the press as a subspecies of industrial spy, but with different motivations. The press isn’t interested in a competitive advantage over its targets;it is interested in a “newsworthy” story.This would be the Washington City Pages publishing the video rental records of Judge Bork (which led to the Video Privacy Protection Act of 1988), the British tabloids publishing private phone conversations between Prince Charles and Camilla Parker Bowles, or a newspaper doing an exposé on this company or that government agency.


pages: 345 words: 87,745

The Power of Passive Investing: More Wealth With Less Work by Richard A. Ferri

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asset allocation, backtesting, Bernie Madoff, capital asset pricing model, cognitive dissonance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, endowment effect, estate planning, Eugene Fama: efficient market hypothesis, fixed income, implied volatility, index fund, Long Term Capital Management, passive investing, Ponzi scheme, prediction markets, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, too big to fail, transaction costs, Vanguard fund, yield curve

The questionnaire approach probably works better on young investors, who have a lot more in common with one another than people in their 50s and 60s. More established investors should not rely solely on questionnaires for determining their risk level. More thought and attention should be given to their unique situation. Finding a person’s maximum tolerance for risk requires soul-searching. We tend to feel brave when prices are going up, which means that it’s not the ideal time to decide our risk tolerance level. Perhaps the best time to decide is after the market has dropped 20 or 30 percent when we’re likely to be more honest with ourselves. No one can guarantee that any investment strategy will achieve its stated objective. However, emotionally-charged selling in a bear market will almost guarantee that an investment plan will be derailed. The level of risk in an investment plan needs to be at a low enough level so that the plan will be diligently followed in all market conditions.

registered investment advisor (RIA) An investment professional who is registered—but not endorsed—by the Securities and Exchange Commission (SEC) and may recommend certain types of investment products. reinvestment Use of investment income to buy additional securities. Many mutual fund companies and investment services offer the automatic reinvestment of dividends and capital gains distributions as an option to investors. return of capital A distribution that is not paid out of earnings and profits. It is a return of the investor’s principal. risk tolerance An investor’s ability or willingness to endure declines in the price of investments while waiting for them to increase in value. R-squared A measure of how much of a portfolio’s performance can be explained by the returns on the overall market (or a benchmark index). If a portfolio’s total return precisely matched the return on the overall market or benchmark, its R-squared would be 1.00.

active management of benchmark tracking and brokerage use of first of the growth in market introduction of taxes and turnover within U.S. equity Index investing, Wall Street’s battle against IndexUniverse.com Individual investor(s): asset allocation for asset side and assets to obligations beginning at the end hiring an advisor human vs. monetary capital investment decisions needs identification and obligations, estimation of risk tolerance of Individual Retirement Account (IRA) Inflation expectation Inheritances Institutional investors Insurance, types of Internal Revenue Service (IRS) International equity funds International risk premiums Internet investment resources Intrinsic value of stocks Invesco PowerShares Investment Advisers Act of 1940 Investment advisors Investment Company Act of 1940 Investment monitoring Investment Performance Measurement Investment policy changes Investment Policy Statement (IPS): as guidebook life obligations and rebalancing and steps leading to Investment pyramid Investments, savings and Investment selection: asset classes and commodities and inflation rate and low-cost index funds/EFTs Investment strategy options Investors.


pages: 257 words: 13,443

Statistical Arbitrage: Algorithmic Trading Insights and Techniques by Andrew Pole

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algorithmic trading, Benoit Mandelbrot, Chance favours the prepared mind, constrained optimization, Dava Sobel, Long Term Capital Management, Louis Pasteur, mandelbrot fractal, market clearing, market fundamentalism, merger arbitrage, pattern recognition, price discrimination, profit maximization, quantitative trading / quantitative finance, risk tolerance, Sharpe ratio, statistical arbitrage, statistical model, stochastic volatility, systematic trading, transaction costs

Our aversion to risk is then taken to be a constant multiple of that variance. Thus, the goal becomes: Maximize expected return subject to a limit on expected variance of return. Let us express these results in mathematical form. First, definition of terms: n fi ip k Number of stocks in investment universe Expected forecast return for stock i; f = (f1 , . . . , fn ) Expected variance of returns, V[f ] Value to be invested in stock i; p = (p1 , . . . , pn ) Risk tolerance factor Now the goal is expressed as: maximize p f − kp p 29 Statistical Arbitrage 2.5.1 Exposure to Market Factors Statistical arbitrage fund managers typically do not want a portfolio that takes long positions only: Such a portfolio is exposed to the market. (A pairs trading scheme, by definition, will not be biased but statistical arbitrage models more generally readily generate forecasts that, unless constrained, would lead to a portfolio with long or short bias.)

A big win pays for many small losses. The significance of this fact is in directing a manager to construct stop loss rules (early exit from a bet that is not working according to forecast expectation) that curtail losses without limiting gains. Where this is possible, a model with seemingly textbook sized relative odds in favor of winning forecasts can be profitably traded within prescribed risk tolerances. Technically, such rules modify the utility function of a model by altering the characteristics of the outcome set by employing a procedure in which the forecast model is only one of several elements. A warning: Beware of being fooled by purveyors of tales of randomness. A strategy that offers bets that typically generate a small loss and occasionally a whopping gain sounds alluring when proffered as relief after a cunningly woven web of disaster shown to seemingly inevitably follow plays where the odds are conventionally in favor of winning.

However, looking at returns between events, the correlation is much higher at 0.7. Event correlation 70 SAI FRE 60 50 40 30 20 10 19960102 19961231 19971231 FIGURE 8.1 Adjusted price histories for FRE and SAI 19980806 143 Nobel Difficulties 70 SAI FRE 60 50 40 30 20 10 19960102 19961231 19971231 19980806 FIGURE 8.2 Adjusted price histories for FRE and SAI to August 1998 indicates what might be expected to trade well in groups within prescribed risk tolerances (see Chapter 2). Visually and statistically, it looks as though the pair [FRE, SAI] will trade profitably in a simple spread reversion model. Simulation of a basic popcorn process model (see Chapter 2) demonstrates that was indeed the case. Figure 8.2 shows the adjusted price series for FRE and SAI extended through the second quarter of 1998 to August 6. Interesting? The spread widened considerably to more than double the recent historical maximum.


pages: 194 words: 59,336

The Simple Path to Wealth: Your Road Map to Financial Independence and a Rich, Free Life by J L Collins

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asset allocation, Bernie Madoff, compound rate of return, diversification, financial independence, full employment, German hyperinflation, index fund, nuclear winter, passive income, payday loans, risk tolerance, Vanguard fund, yield curve

You might leave a high-paying job to work for less at something you love. In my own career there were many times I chose to step away from working for months or even years at a time. Each time changed my stage. Using this framework of two stages and two funds, you have all the tools you need to find your own balance. In determining that balance you’ll also want to consider two additional factors: How much effort you are willing to apply and your risk tolerance. Effort For the wealth accumulation stage an allocation of 100% stocks using VTSAX is the soul of simplicity. But as we’ve seen, some studies suggest that adding a small percentage of bonds—say 10-25%—actually outperforms 100% stocks. You can see this effect by playing with the various calculators found on the internet. As you do, you’ll notice that adding much beyond 25% bonds begins to hurt results.

After considering effort and risk, here are some questions you’ll want to consider. When should I make the shift into bonds? This is very much a function of your tolerance for risk and your personal situation. For the smoothest transition, you might start slowly shifting into your bond allocation 5 or 10 years before you are fully retired. Especially if you have a fixed date firmly in mind. But if you are flexible as to your retirement date and more risk tolerant, you might stay fully in stocks right up until you make the change. In doing so the stronger potential of stocks could get you there sooner. But if the market moves against you, you’ll have to be willing to push your retirement date back a bit. Of course, any time you shift between the accumulation and preservation stages, you’ll want to reassess and possibly adjust your allocation. Balance and choice.


pages: 252 words: 70,424

The Self-Made Billionaire Effect: How Extreme Producers Create Massive Value by John Sviokla, Mitch Cohen

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Cass Sunstein, Colonization of Mars, Daniel Kahneman / Amos Tversky, Elon Musk, Frederick Winslow Taylor, game design, global supply chain, James Dyson, Jeff Bezos, John Harrison: Longitude, Jony Ive, loss aversion, Mark Zuckerberg, market design, paper trading, RAND corporation, randomized controlled trial, Richard Thaler, risk tolerance, self-driving car, Silicon Valley, smart meter, Steve Ballmer, Steve Jobs, Steve Wozniak, Tony Hsieh, Toyota Production System, young professional

MORE EVIDENCE THAT BILLIONAIRES ARE NOT BIG RISK TAKERS We were surprised, and somewhat skeptical, by our finding that billionaires do not possess a greater tolerance for risk than the average businessperson—the cliché of the entrepreneur as risk taker is so strong and pervasive in business culture. Yet as we thought about it more and did more research, it became clear that the issue is not risk tolerance but risk attitudes. Billionaires do not overweigh failure, nor do they take irrational risks. One story that Dean Spanos, son of the billionaire Alex Spanos, shared with us when we sat down with him and his siblings in Stockton, California, underscores this idea of the kind of risks billionaires are—and are not—willing to take. “We were interested in buying a savings and loan about twenty years ago in Florida,” Dean Spanos began, “so Jerry Murphy, the CFO, and Dad and I flew to Florida and we went into this meeting where there was a conference table as long as the room filled with attorneys and investment bankers.

Look for ways to challenge your talent. Give emergent Producers projects or roles that stretch their skills. The ones you think have huge potential should be given a chance to try out important roles that you aren’t sure they can handle yet. You are not setting up anyone to fail. On the contrary, you are challenging them to succeed. When you give people something they have to reach for, their risk tolerance increases and you give them a chance to show themselves what they are capable of. Ideally, the Producers you challenge have either a proven track record or a palpable ability to see the upside—opportunities lost should be as salient to them as risks avoided. When deciding who should get what role or opportunity, make sure as well that the managers and leaders evaluating the options also have the appropriate risk balance in mind.


pages: 519 words: 118,095

Your Money: The Missing Manual by J.D. Roth

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Airbnb, asset allocation, bank run, buy low sell high, car-free, Community Supported Agriculture, delayed gratification, diversification, diversified portfolio, estate planning, Firefox, fixed income, full employment, Home mortgage interest deduction, index card, index fund, late fees, mortgage tax deduction, Own Your Own Home, passive investing, Paul Graham, random walk, Richard Bolles, risk tolerance, Robert Shiller, Robert Shiller, speech recognition, traveling salesman, Vanguard fund, web application, Zipcar

As with so many aspects of investing, there's no one option that works for every person. One factor that can help you decide how to invest your money is risk tolerance. That's a measure of how much uncertainty—and possible loss—you're willing to deal with in your investments. If your risk tolerance is high, you can handle big fluctuations in your investment returns in exchange for the possibility of large gains. If your tolerance is low, on the other hand, you'd rather not deal with the ups and downs—even if that means giving up a chance at making higher returns. Some of your portfolio should be in fixed-income investments like bonds and CDs, which pay interest on a regular schedule. How much depends on your goals, needs, and risk tolerance. A common rule of thumb is that the percentage of fixed-income investments in your portfolio should be equal to your age.

Lifecycle funds are perfect for investors who don't want to worry about all the jargon and nonsense that usually come with investing. If you decide to buy a lifecycle fund, buy only that fund. If you spread your money around (especially to other lifecycle funds), you defeat the whole purpose of this kind of investment. Note You don't have to pick a lifestyle fund that matches your likely retirement date. Instead, choose one that matches your risk tolerance. If the Fidelity Freedom 2035 is too aggressive for you, for example, go with the Fidelity Freedom 2025 instead. You can read more about lifecycle funds in this New York Times article: http://tinyurl.com/NYT-tdfunds. All-in-one funds If you like the idea of investing in just one fund but you don't want its asset allocation to change over time, you have a handful of other single-fund options, including: Vanguard STAR Fund (VGSTX), a collection of 11 other Vanguard mutual funds.


pages: 490 words: 117,629

Unconventional Success: A Fundamental Approach to Personal Investment by David F. Swensen

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asset allocation, asset-backed security, capital controls, cognitive dissonance, corporate governance, diversification, diversified portfolio, fixed income, index fund, law of one price, Long Term Capital Management, market bubble, market clearing, market fundamentalism, passive investing, pez dispenser, price mechanism, profit maximization, profit motive, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Silicon Valley, Steve Ballmer, technology bubble, the market place, transaction costs, Vanguard fund, yield curve

Seduced by the appeal of security-trading decisions and the allure of market-timing moves, investors tend to focus on unproductive and expensive portfolio-churning activities. While hot stocks and brilliant timing make wonderful cocktail party chatter, the conversation-stopping policy portfolio proves far more important to investment success. The essence of the process that leads to creation of viable portfolio targets involves knowledge of basic investment principles, definition of specific investment goals, and understanding of individual risk tolerances. Fundamental investment tenets provide the framework upon which investors build portfolios with the greatest probability of meeting investor needs. Clear articulation of goals defines the task that investors desire to accomplish, while explicit specification of risk preferences outlines the parameters within which investors sensibly operate. Investors armed with basic investment principles, well-defined goals, and reasonable self-awareness increase the likelihood of investment success.

Fully 70 percent of assets promise equity-like returns, meeting the requirement of equity orientation. Asset-class weights range from 5 to 30 percent of assets, meeting the requirement of diversification. A portfolio with assets allocated according to fundamental investment principles establishes a strong starting point for individual investment programs. Ultimately, successful portfolios reflect the specific preferences and risk tolerances of individual investors. Understanding the quantitative and qualitative characteristics of asset-class exposure creates a basis for determining which asset classes to include and in which proportions to invest. Chapter 2, Core Asset Classes, offers a primer on those asset classes likely to contribute to investor goals. Chapter 3, Portfolio Construction, outlines a methodology that blends science and art in combining the core asset classes to produce a portfolio.

Diversification provides the free lunch of improved return and risk characteristics, while equity orientation promises the possibility of greater wealth accumulation. Personal preferences play a critical subjective role in portfolio decision making. Unless an investor embraces wholeheartedly a particular portfolio structure, failure awaits. Lightly held positions invite casual reversal, exposing vacillating investors to the costly consequences of market whipsaw. By adopting asset-allocation targets that dovetail with personal risk tolerances, investors vastly increase the odds of investment success. Individual circumstances introduce important considerations to the portfolio structuring process. Nonfinancial assets, such as homes and privately held businesses, influence an investor’s desired portfolio composition. Financial liabilities, such as mortgages and personal loans, factor into investor decisions regarding asset allocation, particularly with respect to holdings of fixed income.


pages: 304 words: 22,886

Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler, Cass R. Sunstein

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Al Roth, Albert Einstein, asset allocation, availability heuristic, call centre, Cass Sunstein, choice architecture, continuous integration, Daniel Kahneman / Amos Tversky, desegregation, diversification, diversified portfolio, endowment effect, equity premium, feminist movement, framing effect, full employment, George Akerlof, index fund, invisible hand, late fees, libertarian paternalism, loss aversion, Mahatma Gandhi, Mason jar, medical malpractice, medical residency, mental accounting, meta analysis, meta-analysis, Milgram experiment, pension reform, presumed consent, profit maximization, rent-seeking, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Saturday Night Live, school choice, school vouchers, transaction costs, Vanguard fund, Zipcar

To test this prediction, Benartzi and Thaler (2001) examined behavior in retirement saving plans of 170 companies. They found that the more stock funds the plan offered, the greater was the percentage of participants’ money invested in stocks. Many plans have attempted to help participants deal with the difficult problem of portfolio construction by offering “lifestyle” funds that blend stocks and bonds in a way designed to meet the needs of different levels of risk tolerance. For example, an employer might offer three lifestyle funds: conservative, moderate, and aggressive. These funds are already diversi- NAÏVE INVESTING fied, so individuals need pick only the fund that fits their risk preference. Some funds also adjust the asset allocation with the age of the participant. Such a fund assortment is a good idea and represents an excellent set of default options (if the fees are reasonable).

AARP, 161–62, 163–64 ABBA, Gold: Greatest Hits, 194 “above average” effect, 32, 224 Abu Ghraib prison, 245 accessibility, 25 accountability, in schools, 200 acid deposition program, 187–88 acid rain, 187–88 air conditioners, filters for, 234 air pollution, 183, 184–85, 186, 188 alcohol abuse, 67–68, 234–35 Ambient Orb, 194 American dream, 135 American Express, 35 anchoring and adjustment, 23–24 angels, 235 annual percentage rate (APR), 133, 137 anonymity, 57 arbitrage opportunity, 51 arousal, power of, 42 asbestos, warnings about, 189 Asch, Solomon, 56–59 aspects, elimination by, 95 asset allocation, 34–35, 118–28; company stock, 125–28; diversification heuristic, 123; and loss aversion, 120–21; and market timing, 121–22; mutual funds, 119; and rates of return, 123; and risk toler- ance, 124–25; rules of thumb for, 122– 25; stocks and bonds, 118, 119–20 asymmetric paternalism, 72n, 249–51 ATM cards, 88 attention, lack of, 35 Attila the Hun, 23–24 Austria, organ donations in, 178–79 autokinetic effect, 57 automatic pilot, 43 Automatic System, 19–22; and Doers, 42; mindless choosing by, 43–44; and priming, 69–71; and risk, 25; in Stroop test, 82; and temptation, 42 Automatic Tax Return, 230–31 automobiles: buying, 98–99, 138; catalytic converters for, 184; emissions from, 184, 186; fuel economy standards for, 191–92, 192, 193; gas tank caps, 88–89; user-friendly, 88; Zipcar rentals, 99n autopsies, corneas removed in, 177 availability bias, 24–26, 67 Ayres, Ian, 231–32 “back to zero” option, 12–13 Barrera, Ramiro, 163 basketball: “hot hands” in, 30, 31; “streak shooting,” 30 283 284 INDEX behavior: dynamically inconsistent, 41; risk-related, 7, 25, 32–33 Benartzi, Shlomo, 112, 124, 127 Bennett, Robert, 14 Bettinger, Eric, 141 Big Blue, 6 birth control pills, 89 Bismarck, Otto von, 105 boomerang effect, 68 borrowing, 132; see also credit markets Boston, school system in, 203–5 Boston Research Group, 126 brain, functioning of, 19–22 Brandeis, Louis, 240 brand switching, 64–65 Breman, Anna, 229 broadcast programming, 55 Burke, Edmund, 238n Bush, George H.

., 220–21; status quo bias in, 217; use of term, 215–16, 218; variations on a theme, 221 McAllen, Texas, Medicare Part D in, 162– 63 McFadden, Daniel, 171 Medicaid, and Medicare Part D, 161, 164 Medicare Advantage, 165, 170 Medicare Part D, see prescription drug plan Medicare Web site, 162, 168–70, 173 mental accounting, 49–52 mere-measurement effect, 70 Merrell, Katie, 169 Métro, Le, Paris, 87 Meulbroek, Lisa, 127 microfinance loans, 135 mistakes, learning from, 241 MIT, Poverty Action Lab, 232 money: borrowing, 103; as fungible, 50; liquid assets of households, 51; personal savings, 103; for retirement, see retirement plans; Save More Tomorrow, 112– 17 money illusion, 112 money market accounts, 118, 126, 129 Montana, social influence in, 68 mortgage brokers, 134n, 135, 138 mortgages, 132–38; and the American dream, 135; annual percentage rate (APR), 133, 137; costs of, 93; fees, 133, 137, 138; fixed-rate, 133; and foreclosures, 136–37; “good-faith estimate” in, 136; interest-only, 133; online shopping for, 138; points, 133, 136; prepayment penalties, 133, 136; and RECAP, 137–38; research findings about, 134; in subprime market, 134–38; and teaser rates, 133, 138; and Truth in Lending Act, 133, 136, 137; variable-rate, 133, 138 motorcycle helmets, 232–33 music downloads, 62–63 mutual funds, 119, 120, 122, 127 MySpace, 182 nail polish, no-bite, 234 National Association of Chain Drug Stores, 172 National Community Pharmacists Association, 172 National Environmental Policy Act (1972), 189–90 Nazism, 59 negligence: defined, 213; right to sue for, 207–14 negotiations, opening offers in, 24 Nelson, Willie, 60 neutrality, 243, 246–48 New Deal, 252 289 290 INDEX No Child Left Behind Act, 85–86, 200– 201 noodge, meaning of term, 4n Norman, Don, The Design of Everyday Things, 83 nudge, use of term, 6, 8 nudges, evaluation of, 247 obesity, 7; and conformity, 64; and selfcontrol, 44; and social influence, 55 Occupational Safety and Health Administration (OSHA), 189, 251 One Size Fits All, 9 optical illusions, 17–19 optimism, 31–33 “opt-in” policy, 86, 109, 110 “opt-out” policy, 86, 109, 248–49, 251 Oreopoulos, Phil, 141 organ donations, 157–58, 175–82; “brain dead” sources of, 176; complexities in, 179–80; default rule in, 176, 179; explicit consent in, 176–77, 178, 179; inertia in, 176; mandated choice, 180; market in, 175n; presumed consent, 177–79, 180; rejection rate in, 179; routine removal, 177; social norms, 180–82 overconfidence, 31–33 ozone layer, 183 painting a ceiling, 91 paint store, 95–96 Parker, Tom, Rules of Thumb, 22 parking garages, 87–88 paternalism: asymmetric, 72n, 249–51; and coercion, 11, 236–38; of government, 47; “one-mouse-click,” 249; One Size Fits All, 9; rejection of, 9; stopping point for, 251; use of term, 5 pedestrians, 90 peer pressure, 54, 55, 71 Pension Protection Act (2006), 115–16 pensions, see retirement plans pesticides, warnings about, 189 Petrified Forest National Park, Arizona, 66–67 Planners, 42, 47 planning fallacy, 7 pluralistic ignorance, 59 politics: brand switching in, 65; libertarian paternalism in, 13–14, 237; predictions in, 20n; private-sector interests in, 240; probability of voting, 70; Third Way in, 252–53; voting patterns, 55, 246 pollution, 183, 184–85, 186, 188 popcorn, 43 portfolio theory, 123 postcompletion errors, 88 practice, 74–75; and feedback, 75 preferences, 75–76 Prelec, Drazen, 143 prescription drug plan, 157, 159–74; available alternative plans, 161; confusing choices in, 160, 162–65; coverage in, 162; defects of, 160; design of, 160–62; “doughnut hole” in, 162; and drug prices, 168; dual eligibles in, 166, 167; enrollment routes, 164–65; failure to serve, 160; flexible switching option in, 166, 167–68, 174; individuals with no coverage, 164, 165; intelligent assignment in, 171–73; key features of, 161; lessons to be learned from, 174; as Medicare Part D, 159–62; minimum coverage requirements for, 160; nonenrollment as default option, 160; and pharmacy networks, 260n16; poor choices made in, 170–71; price differences in, 170; random default, 160, 165–68, 171–73; RECAP proposal for, 173–74; restructuring of, 166; simplicity needed in, 174; Web site as tool for, 162, 168–70 Prestwood, Charlie, 125–26 presumed consent, and organ removal, 177–79, 180 prices, and incentives, 97–100 priming, 69–71 procrastination, 238n publicity principle, 243–46 public policy, and framing, 36–37 random processes: neutrality in, 246; patterns in, 27; “streak shooting,” 30 Rawls, John, 244 INDEX Read, Daniel, 123 RECAP (Record, Evaluate, Compare Alternative Prices), 93–94; and credit cards, 143–44; and Medicare Part D, 173–74; and mortgages, 137–38; and student loans, 141; and transparency, 240 recycling, 66n redistribution, 241–43 Reflective System, 19–22; and Planners, 42 Regulation Z (Truth in Lending Act), 133, 136, 137 representativeness, 26–31 required choice, 86–87 restaurant health inspection, 190n retirement plans: automatic enrollment in, 109, 130; automatic savings for, 108–9; choice architecture in, 129; choosing, 76; complex choices in, 130; conflicts of interest in, 131; contribution rates, 110– 11; default options in, 129–30; definedbenefit, 105, 108; defined-contribution, 105–6, 107, 123, 128, 129; discretionary contributions to, 127; diversification rule of, 128; education about, 111–12; enrollment decisions, 107–8; ERISA, 127–28, 131; errors expected in, 130; exclusive benefit rule of, 128; feedback in, 131; forced choice in, 109–10; “free money” in, 108; and government, 115– 17; incentives in, 131; investments for, see investments; and job switching, 105; mappings in, 131; matching contributions to, 108, 111, 127; and mindless choosing, 44; obstacles to saving for, 112; portable, 106; postretirement income needed in, 106–7; prudence rule of, 128; “safe harbor status” for, 129; Save More Tomorrow, 112–17, 130, 245; saving for, 103–7; simplicity in, 110; status quo bias in, 34–35, 112; synchronized to pay raises, 113; tax-favored savings accounts, 103 right to be wrong, 241 risk assessment, 25–26, 118 risk-related behavior, 7, 25, 32–33 risk tolerance, 124–25 Robur Aktiefond Contura, Sweden, 152– 53 Rogers, Kenny, “The Gambler,” 121 Romalis, John, 46–47 Roosevelt, Franklin D., 199, 206, 252 Roth, Al, 204 rules of thumb, 22–31; anchoring, 23–24; availability, 24–26; in investments, 122– 25; representativeness, 26–31; systematic biases in, 23 Rules of Thumb (Parker), 22 Rumsfeld, Donald, 86 saccharine, warnings about, 189 Saks, Michael, 176 Salganik, Matthew, 62–63 salience, 25, 98–99 same-sex relationships, 215, 220 Samuelson, William, 34 San Marcos, California, energy use in, 68–69 San Marcos, Texas, schools, 205–6 Santorum, Rick, 14 Save More Tomorrow, 112–17, 245; and automatic enrollment, 130; contributions synchronized to pay raises, 113; government role in, 115–17; obstacles to saving, 112–15; and Pension Protection Act, 115–16 scents, as cues, 71 Schiphol Airport, Amsterdam, men’s rooms in, 4 Sears, profit-sharing plan, 258n12 Seattle Windshield Pitting Epidemic, 63– 64 self-control: with credit cards, 143; and gambling, 233; market-driven, 48; and mindless choosing, 44; and Save More Tomorrow, 112; sinful goods, 73; strategies for, 44–49; and temptation, 42, 44–49; two-system conception of, 42 Sell More Tomorrow, 128 Shaikh, Altaf, 135 Shea, Dennis, 109 Shepard, Roger, 19 Sherif, Muzafer, 57–58 291 292 INDEX Shu, Suzanne, 133 Silverstein, Shel, “Smart,” 77–78 similarity heuristic, 26 Simister, Duncan, 143 simplifying strategies, 95–96 sinful goods, 73 slippery-slope argument, 236–38, 251 smoking: CARES, 232; intrusive paternalism vs., 236–37; quitting without a patch, 232; risks of, 189; and self-control, 44, 47; and social influence, 68 Snow, Tony, 103, 107 social influences, 53–71; as choice architecture, 65–69; conformity, 55–60; and cultural change, 62–65; in health care, 157; and information, 54, 71; in Jonestown, 53, 54; learning from others, 54; in peer pressure, 54, 71; power of, 55; priming, 69–71; spotlight effect, 60–62; and unpredictability, 62–65 “social norms” approach, 67–68, 180–82 Social Security, 52, 103, 105, 116–17, 145– 56, 251; and advertising, 153–56; default fund for, 146–49; lessons learned from the Swedish experience, 155–56; simplified choice process, 156; Swedish privatization of, 145–55; and timing, 153 Souleles, Nick, 51 Southern California Edison, 194 Spain, organ donations in, 179 spotlight effect, 60–62 Stafford loans, 139 status quo bias: and default option, 8, 12– 13, 35, 83; in education, 201–2; as inertia, 7–8, 34–35; and lack of attention, 35; and magazine subscriptions, 35, 85; in marriage, 217; in retirement savings, 34–35, 112 Stewart, Potter, 41 Stickk.com, 47, 231–32 Stigler, George, 208 stimulus response compatibility, 82 stocks and bonds, 118, 119–20; company stock, 125–28, 247; diversification of, 123, 127, 128; and environmental black- list, 191; market timing, 121–22; Sell More Tomorrow, 128 strategic misrepresentation, 203–4 Stroop test, 82 student loans, 138–41; avoiding, 141; college savings accounts (529 plans), 141; expected family contribution in, 139; FAFSA for, 139, 141; as opportunity to fleece confused consumers, 141; from private sector, 139–40; RECAP applied to, 141 subliminal advertising, 243–46 subprime mortgages, 134–38 sunlamps, 249–50 supply and demand, 97 Sweden, in world economy, 151 Swedish Social Security, 145–55; active choosers in, 149–53; advertising, 154– 55; asset allocation in, 149; availability bias in, 155; default fund of, 146–49, 150, 152, 155–56; inertia in, 155; Just Maximize Choices in, 145–46, 155; lessons learned from, 155–56 table test, 17–19 “target maturity funds,” 129–30 tax-favored savings accounts, 103 Tax Return, Automatic, 230–31 teenage pregnancy, 55, 234 television, default option in, 35 temptation, 40–52; and arousal, 42; cashew phenomenon, 40–41, 43; and “hot-cold empathy gap,” 42; and mental accounting, 49–52; and mindless choosing, 43–44; and packaging, 44; and self-control, 42, 44–49; sinful goods, 73; of Ulysses, 41–42, 48, 219– 20 terror alert system, 91 tetanus shots, 71 Texas, anti-littering campaign in, 60, 61 Thaler, Richard H., and Save More Tomorrow, 112–15 thinking, in Reflective System, 19–20 Third Way, 252–53 Thompson, Clive, 193–94 INDEX TIAA-CREF, 34–35, 123 Tierney, John, 232–33 Toxic Release Inventory, 190–92 tragedy of the commons, 185 transparency, 240, 244–46 Truth in Lending Act (Regulation Z), 133, 136, 137 Tversky, Amos, 23, 95 Ulysses, resisting temptation, 41–42, 48, 219–20 unpredictability, 62–65 user ratings, 96 U.S.


pages: 339 words: 109,331

The Clash of the Cultures by John C. Bogle

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asset allocation, collateralized debt obligation, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, Flash crash, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, market bubble, market clearing, mortgage debt, new economy, Occupy movement, passive investing, Ponzi scheme, principal–agent problem, profit motive, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, statistical arbitrage, The Wealth of Nations by Adam Smith, transaction costs, Vanguard fund, William of Occam

In the fund industry, service excellence is becoming a commodity—as it must be for any service industry. Both organizational structures honor the tenet, “Treat your customers as if they were your owners.” But only the mutual organization can, with accuracy, tack on the phrase, “because your customers are your owners.” Risk Management Strategy. In conventionally operated mutual funds, investment strategy can, in the search for higher returns, be risk-tolerant, so long as a fund’s risk—usually measured by its short-term price volatility—is consistent with the risks assumed by its peer funds. A mutual organization’s investment strategy can afford to be risk-intolerant. With costs far below competitive norms, there is little need to reach for slightly higher returns on stock funds or higher yields on bond funds. Assuming portfolio quality is held constant, higher yields can be easily generated simply by lower costs.

So this massive transfer of the two great risks of retirement plan savings—investment risk and longevity risk—from corporate balance sheets to individual households will relieve pressure on corporate earnings, even as it will require our families to take responsibility for their own retirement savings. A further benefit is that investments in properly designed DC plans can be tailored to the specific individual requirements of each family—reflecting its prospective wealth, its risk tolerance, the age of its bread-winner(s), and its other assets (including Social Security). DB plans, on the other hand, are inevitably focused on the average demographics and average salaries of the firm’s work force in the aggregate. The 401(k) plan, then, is an idea whose time has come. That’s the good news. We’re moving our retirement savings system to a new paradigm, one that ultimately will efficiently serve both our nation’s employers—corporations and governments alike—and our nation’s families.

Also, little thought has been given to the design of the post-work asset decumulation phrase. As a result, DC plan investing has been unfocused, and post-work financial outcomes have been, and continue to be highly uncertain, raising fundamental questions about the effectiveness and sustainability of this individualistic pension model. 2. Traditional DB plans lump the young and the old on the same balance sheet, and unrealistically assume they have the same risk tolerance and that property rights between the two groups are clear. These unrealistic assumptions have had serious consequences. Over the course of the last decade, aggressive return assumptions and risk-taking—together with falling asset prices, falling interest rates, and deteriorating demographics—have punched gaping holes in many DB plan balance sheets, to which unfocused responses have ranged the full spectrum—from complete de-risking at one end to piling on more risk at the other . . .


pages: 353 words: 88,376

The Investopedia Guide to Wall Speak: The Terms You Need to Know to Talk Like Cramer, Think Like Soros, and Buy Like Buffett by Jack (edited By) Guinan

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Albert Einstein, asset allocation, asset-backed security, Brownian motion, business process, capital asset pricing model, clean water, collateralized debt obligation, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, equity premium, fixed income, implied volatility, index fund, interest rate swap, inventory management, London Interbank Offered Rate, margin call, market fundamentalism, mortgage debt, passive investing, performance metric, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, statistical model, time value of money, transaction costs, yield curve, zero-coupon bond

Fixed assets are expected to provide benefits beyond one year: manufacturing equipment, buildings, and real estate. Related Terms: • Balance Sheet • Depreciation • Tangible Asset • Current Assets • Intangible Asset 14 The Investopedia Guide to Wall Speak Asset Allocation What Does Asset Allocation Mean? An investment strategy that aims to balance risk and reward by spreading investments across three main asset classes—equities, bonds, and cash—in accordance with an individual’s goals, risk tolerance, and investment horizon. Historically, different asset classes have varying degrees of risk and return and therefore behave differently over time. Investopedia explains Asset Allocation There is no simple formula to determine the proper asset allocation for every individual. However, the consensus among financial professionals is that asset allocation is one of the most important investment components.

A group of investments such as stocks, bonds and cash equivalents, mutual funds, exchange-traded funds, and closed-end funds that are selected on the basis of an investor’s short-term or long-term investment goals. Portfolios are held directly by investors and/or managed by financial professionals. Investopedia explains Portfolio Prudence suggests that investors construct an investment portfolio in accordance with their risk tolerance and investment objectives. One should think of an investment portfolio as a pie that is divided into pieces of varying sizes that represent a variety of asset classes and/or types of investments to accomplish an appropriate riskadjusted return. For example, a conservative investor may favor a portfolio with large-cap value stocks, broad-based market index 226 The Investopedia Guide to Wall Speak funds, investment-grade bonds, and cash.

Low levels of uncertainty (low risk) are associated with low potential returns, whereas high levels of uncertainty (high risk) are associated with high potential returns. According to the risk-return trade-off, invested money can render higher profits only if it is subject to the possibility of being lost. Investopedia explains Risk-Return Trade-Off Because of the risk-return trade-off, investors must recognize their personal risk tolerance when choosing investments. Taking on additional risk is the price of achieving potentially higher returns; therefore, if an investor wants to make money, he or she cannot cut out all risk. The goal instead is to find an appropriate balance that generates some profit but allows the investor to sleep at night. Related Terms: • Modern Portfolio Theory—MPT • Return • Risk-Free Rate of Return • Opportunity Cost • Risk Risk-Weighted Assets What Does Risk-Weighted Assets Mean?

The Smartest Investment Book You'll Ever Read: The Simple, Stress-Free Way to Reach Your Investment Goals by Daniel R. Solin

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asset allocation, corporate governance, diversification, diversified portfolio, index fund, market fundamentalism, passive investing, prediction markets, random walk, risk tolerance, risk-adjusted returns, risk/return, transaction costs, Vanguard fund

Brokerage fees charged by U.S. brokers for ETF trades are generally lower than fees charged in Canada. 3. Invest the stock and bond portions of your portfolio in the ETFs described in this book. lllO The Heal Way Smart Investors Beat 95%of the ~Pros" 4. RebaJance your portfolio twice a year to keep your portfolio either aJigned with your original asset aJlocarion or with a new asset allocation that meets your changed investment objectives and/or risk tolerance. T hat's it. Read on for more details on each step. Chapter 34 Step 1: Determine Your Asset Allocation Over 90% ofinvestment returns are determined by how investors allocate their assets versus security selection, market timing and other foctors. -Brinson, Singer and Beebower, "Determinants of Portfolio Performance II : An Update, n Financial Analysts JournaL. May-June 1991 Asset allocation is the division of an investment portfolio among three rypes of invc.


pages: 44 words: 13,346

Extreme Early Retirement: An Introduction and Guide to Financial Independence (Retirement Books) by Clayton Geoffreys

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asset allocation, dividend-yielding stocks, financial independence, index fund, passive income, risk tolerance

Throughout the next pages, you will be learning more about passive income but the basic idea is to couple your active income with various sources of passive income. Two of the most common sources that early retirees can live with are dividend-yielding stocks and rental properties. However, every source of passive income requires an investment and nearly all kinds of investments involve risk. It is important for you to calculate your risk tolerances and consider safer options so you do not end up burning your savings. 5 Reasons You Should Consider Extreme Early Retirement You Will Have More Time Enjoying the Goodness in Life The average age when people retire is 65 or 70, and if you think about it, people spend more time working instead of living. Our life is centered on work and oftentimes, it almost feels like we only ‘live to work’.


pages: 412 words: 115,266

The Moral Landscape: How Science Can Determine Human Values by Sam Harris

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Albert Einstein, banking crisis, cognitive bias, endowment effect, energy security, experimental subject, framing effect, hindsight bias, impulse control, John Nash: game theory, loss aversion, meta analysis, meta-analysis, out of africa, pattern recognition, placebo effect, Ponzi scheme, Richard Feynman, Richard Feynman, risk tolerance, stem cell, Stephen Hawking, Steven Pinker, the scientific method, theory of mind, ultimatum game, World Values Survey

In evaluating the problem of global warming, one must weigh the risk of melting the polar ice caps; in judging the ethics of capital punishment, one must consider the risk of putting innocent people to death. However, people differ significantly with respect to risk tolerance, and these differences appear to be governed by a variety of genes—including genes for the D4 dopamine receptor and the protein stathmin (which is primarily expressed in the amygdala). Believing that there can be no optimal degree of risk aversion, Burton concludes that we can never truly reason about such ethical questions. “Reason” will simply be the name we give to our unconscious (and genetically determined) biases. But is it really true to say that every degree of risk tolerance will serve our purposes equally well as we struggle to build a global civilization? Does Burton really mean to suggest that there is no basis for distinguishing healthy from unhealthy—or even suicidal—attitudes toward risk?

See cultural relativism; moral relativism religion: afterlife and, 18, 33 belief in God’s existence, 6–7, 25, 158, 159, 165–66 belief in Jesus, 137–38 brain science and, 128, 152–54, 232n37, 233nn 48–49, 234n54 Burton on, 129 children and, 151 cognitive templates for, 150–51 corporal punishment in schools and, 3 Einstein on, 202n18, 236n77 in Europe, 145–46 evolution and, 147–52 God as Creator, 164 Golden Rule and, 78, 209n45 happiness from, 231–32n15 industrialization and, 145 Jesus as Son of God, 162–63, 167–68 of Judaism, 33, 38 miracles and, 167–68, 237n82 moral law and, 33, 38, 161, 169–70 morality and, 2, 33, 46, 62–63, 78, 146, 191 mysticism and, 128, 235n76 prayer and, 148, 152, 168 problems of, 6, 22–25, 157, 203n19, 227n45 prophecies and, 154–55 reason versus, 158–76 religious practices, 148–49 resurrection of the dead, 166–67 revelation and, 78 science versus, 6, 24–25 scientists’ belief in, 159–76, 237–38n99 scriptures of, 78, 89, 150, 236–37n82 sexual abuse scandal in Catholic Church, 35, 199–201n14 significance of, 154–58, 199n9 social health of least religious countries, 146–47 societal insecurity and, 146–47 soul and, 110, 158–59, 171, 179, 235n66 states of mind at core of, 165 in United States, 145–47, 149–50, 158, 234–35n64 witchcraft compared with, 129–30 See also Catholic Church; Islam religious conservatives, 5–6, 46, 53, 86, 89, 90, 158, 180–81 remembering self, 184–87 Repugnant Conclusion argument, 71 responsibility. See moral responsibility retributive justice, 1, 106, 109, 110–11 reverse inference problem, 212n71, 224n34 right and wrong. See evil; good/goodness; morality; values risk and risk tolerance, 128, 143, 226n35 Rosenhan, David L., 141–42 Ruse, Michael, 48 Rushdie, Salman, 46 Russell, Bertrand, 78 Sai Baba, Sathya, 167–68 Salk Institute, 23–24 sanity, legal definition of, 98 Savoy, R. L., 229n62 schadenfreude, 113, 222n18 schizophrenia, 127, 142, 152, 162, 195n3, 205n24 Schrödinger, Erwin, 213n77 science: belief and, 144 bias of, 47–48 concessions made to religious dogmatism by, 5–6, 22–23 consensus versus controversy in, 31, 198n6 “consilience” in, 8 definition of, 37 doubts about authority of, 47–48 Einstein on religion and, 202n18, 236n77 epistemic values of, 202n16 funding for, 24 growth of scientific knowledge, 124 hostility against, by general public and governments, 24 humility of scientists, 124 hypothesis testing in, 116 moral truth and, 1–4, 28, 46–53 narrow definition of, 29 objectivity and, 29–30, 47, 48 philosophy and, 179–81 religion versus, 6, 24–25 religious beliefs of scientists, 159–76, 237–38n99 reluctance of, to take stand on moral issues, 6–7, 10–11, 22–25, 191 tools of, 29 validity in, 143–44 values and, 1–4, 11, 28, 49–53, 143–44, 189–91, 202n16 See also brain science; brain structures; facts; neuroimaging research; and specific scientists scientism, 46–47 SCNT.

Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies by Jeremy J. Siegel

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asset allocation, backtesting, Black-Scholes formula, Bretton Woods, buy low sell high, California gold rush, capital asset pricing model, cognitive dissonance, compound rate of return, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, joint-stock company, Long Term Capital Management, loss aversion, market bubble, mental accounting, new economy, oil shock, passive investing, prediction markets, price anchoring, price stability, purchasing power parity, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, Vanguard fund

By finding the points on the longerterm efficient frontiers that have a slope equal to the slope on the one-year frontier, one can determine the allocations that represent the same risk-return trade-offs for all holding periods. 34 PART 1 The Verdict of History RECOMMENDED PORTFOLIO ALLOCATIONS What percentage of an investor’s portfolio should be invested in stocks? The answer can be seen in Table 2-2, which is based on standard portfolio models incorporating both the risk tolerance and the holding period of the investor.7 Four classes of investors are analyzed: the ultraconservative investor who demands maximum safety no matter the return, the conservative investor who accepts small risks to achieve extra return, the moderate-risk-taking investor, and the aggressive investor who is willing to accept substantial risks in search of extra returns. The recommended equity allocation increases dramatically as the holding period lengthens.

Given these striking results, it might seem puzzling that the holding period has almost never been considered in portfolio theory. This is 7 The one-year proportions (except minimum risk point) are arbitrary and are used as benchmarks for other holding periods. Choosing different proportions as benchmarks does not qualitatively change the analysis. TABLE 2–2 Portfolio Allocation: Percentage of Portfolio Recommended in Stocks Based on All Historical Data Risk Tolerance 1 Year Holding Period 5 Years 10 Years 30 Years Ultraconservative (Minimum Risk) 9.0% 22.0% 39.3% 71.4% Conservative 25.0% 38.7% 59.6% 89.5% Moderate 50.0% 61.6% 88.0% 116.2% Aggressive Risk Taker 75.0% 78.5% 110.1% 139.1% CHAPTER 2 Risk, Return, and Portfolio Allocation 35 because modern portfolio theory was established when the academic profession believed in the random walk theory of security prices.

Campbell, Strategic Asset Allocation: Portfolio Choice for Long-Term Investors, New York: Oxford University Press, 2002. Also see Nicholas Barberis, “Investing for the Long Run When Returns Are Predictable,” Journal of Finance, vol. 55 (2000), pp. 225–264. Paul Samuelson has shown that mean reversion will increase equity holdings if investors have a risk aversion coefficient greater than unity, which most researchers find is the case. See Paul Samuelson, “Long-Run Risk Tolerance When Equity Returns Are Mean Regressing: Pseudoparadoxes and Vindications of ‘Businessmen’s Risk’” in W. C. Brainard, W. D. Nordhaus, and H. W. Watts, eds., Money, Macroeconomics, and Public Policy, Cambridge: MIT Press, 1991, pp. 181–200. See also Zvi Bodie, Robert Merton, and William Samuelson, “Labor Supply Flexibility and Portfolio Choice in a Lifecycle Model,” Journal of Economic Dynamics and Control, vol. 16, no. 3 (July–October 1992), pp. 427–450.


pages: 389 words: 109,207

Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street by William Poundstone

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Albert Einstein, anti-communist, asset allocation, Benoit Mandelbrot, Black-Scholes formula, Brownian motion, buy low sell high, capital asset pricing model, Claude Shannon: information theory, computer age, correlation coefficient, diversified portfolio, en.wikipedia.org, Eugene Fama: efficient market hypothesis, high net worth, index fund, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, John von Neumann, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, New Journalism, Norbert Wiener, offshore financial centre, publish or perish, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, short selling, speech recognition, statistical arbitrage, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, traveling salesman, value at risk, zero-coupon bond

Any long-term “investor” who keeps letting money ride on the second wheel must eventually go bust. The second wheel’s geometric mean is zero. What does mean-variance analysis say? To answer that, you have to compute the variance of the wheels’ returns. I’ll spare you the trouble—the variance of the wheels increases from left to right. So does the arithmetic mean return. Consequently, Markowitz theory refuses to decide among these three wheels. All are legitimate choices. A risk-tolerant investor looking for the highest return might choose the third wheel. A conservative investor willing to sacrifice return for security might choose the first. The middle wheel is good, too, for people in the middle. The last bit of advice is particularly hard to swallow. Most would agree that the middle wheel is the riskiest because it alone poses the danger of total loss. Yet the middle wheel has a lower variance than the third because its outcomes are less dispersed.

If correct, that would imply that the fund’s true compound growth rate was hovering near zero. The familiar mean-variance mapping is not a good way of visualizing this type of problem, noted the University of North Carolina’s Richard McEnally. In the mean-variance mapping (left), return rises as a straight line as leverage increases. Risk rises, too, but this diagram shows no reason why a very aggressive and risk-tolerant trader should not increase leverage to any degree obtainable. In the Kelly mapping (right), the line of return is a curve that boomerangs back to zero and negative returns. Two Views of Risk and Return It is not a question of which mapping is “right.” Both mappings are right for different contexts. The highly leveraged overbettor is likely to do well on many bets that are not parlayed.


pages: 354 words: 26,550

High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems by Irene Aldridge

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algorithmic trading, asset allocation, asset-backed security, automated trading system, backtesting, Black Swan, Brownian motion, business process, capital asset pricing model, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, diversification, equity premium, fault tolerance, financial intermediation, fixed income, high net worth, implied volatility, index arbitrage, interest rate swap, inventory management, law of one price, Long Term Capital Management, Louis Bachelier, margin call, market friction, market microstructure, martingale, New Journalism, p-value, paper trading, performance metric, profit motive, purchasing power parity, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, Small Order Execution System, statistical arbitrage, statistical model, stochastic process, stochastic volatility, systematic trading, trade route, transaction costs, value at risk, yield curve

Order processing costs specific to the market maker’s own trading mechanism—these costs may involve exchange fees, settlement and trade clearing costs, and transfer taxes, among other charges. 3. The information asymmetry cost—a market maker trading with wellinformed traders may often be forced into a disadvantaged trading position. As a result, Stoll’s (1978) model predicts that the differences in bidask spreads between different market makers are a function of the market makers’ respective risk tolerances and execution set-ups. In Ho and Stoll (1981), the market maker determines bid and ask prices so as to maximize wealth while minimizing risk. The market maker controls his starting wealth positions, as well as the amounts of cash and inventory held on the book at any given time. As in Garman (1976), the arrival rates 138 HIGH-FREQUENCY TRADING of bid and ask orders are functions of bid and ask prices, respectively.

The losses may be due to a wide range of events, such as unforeseen trading model shortcomings, market disruptions, acts of God (earthquakes, fire, etc.), compliance breaches, and similar adverse conditions. Determining organizational goals for risk management is hardly a trivial endeavor. To effectively manage risk, an organization first needs to create clear and effective processes for measuring risk. The risk management goals, therefore, should set concrete risk measurement methodologies and quantitative benchmarks for risk tolerance associated with different trading strategies as well as with the organization as a whole. Expressing the maximum allowable risk in numbers is difficult, and obtaining organization-wide agreement on the subject is even more challenging, but the process pays off over time through quick and efficient daily decisions and the resulting low risk. A thorough goal-setting exercise should achieve senior management consensus with respect to the following questions: r What are the sources of risk the organization faces?


pages: 297 words: 91,141

Market Sense and Nonsense by Jack D. Schwager

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asset allocation, Bernie Madoff, Brownian motion, collateralized debt obligation, commodity trading advisor, conceptual framework, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, fixed income, high net worth, implied volatility, index arbitrage, index fund, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, market fundamentalism, merger arbitrage, pattern recognition, performance metric, pets.com, Ponzi scheme, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, statistical arbitrage, statistical model, transaction costs, two-sided market, value at risk, yield curve

Figure 8.1 Two Paths to Return Figure 8.2 Doubling the Exposure of the Lower-Risk Manager What if leverage is not available as a tool? For example, what if investors have a choice between Managers C and D in Figure 8.1, but there are practical impediments to increasing the exposure of Manager D? Now return and risk are inextricably bundled, and investors must choose between the higher-return/higher-risk profile of Manager C and the lower-return/lower-risk profile of Manager D. It might seem that risk-tolerant investors would always be better off with Manager C. Such investors might say, “I don’t care if Manager C is riskier, as long as the end return is higher.” The flaw in this premise is that investors who start with Manager C at the wrong time—and that is easy to do—may actually experience significant losses rather than gains, even if they maintain the investment, and especially if they don’t.

The underwater curve for Manager F remains subdued in the 2DUC chart with a still very low average value of 3 percent. The 2DUC chart implies that the average worst-case scenario for investors with Manager E is 10 times worse than with Manager F; that is a lot of extra risk for a 1.3 percent difference in the average annual compounded return. Based on performance, it would be difficult to justify choosing Manager E over Manager F, even for the most risk-tolerant investor. Figure 8.12 2DUC: Manager E versus Manager F Investment Misconceptions Investment Misconception 23: The average annual return is probably the single most important performance statistic. Reality: Return alone is a meaningless statistic because return can always be increased by increasing risk. The return/risk ratio should be the primary performance metric. Investment Misconception 24: For a risk-seeking investor considering two investment alternatives, an investment with expected lower return/risk but higher return may often be preferable to an equivalent-quality investment with the reverse characteristics.


pages: 153 words: 12,501

Mathematics for Economics and Finance by Michael Harrison, Patrick Waldron

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Brownian motion, buy low sell high, capital asset pricing model, compound rate of return, discrete time, incomplete markets, law of one price, market clearing, risk tolerance, riskless arbitrage, short selling, stochastic process

PORTFOLIO THEORY 115 Theorem 6.3.2 ∃ Two fund monetary separation i.e. Agents with different wealths (but the same increasing, strictly concave, VNM utility) hold the same risky unit cost portfolio, p∗ say, (but may differ in the mix of the riskfree asset and risky portfolio) i.e. ∀ portfolios p, wealths W0 , ∃λ s.t. h E u W0 rf + λW0 p∗ > (r̃ − rf 1) i h i ≥ E u W0 rf + p> (r̃ − rf 1) (6.3.22) ⇐⇒ Risk-tolerance (1/RA (z)) is linear (including constant) i.e. ∃ Hyperbolic Absolute Risk Aversion (HARA, incl. CARA) i.e. the utility function is of one of these types: • Extended power: u(z) = 1 (A (C+1)B + Bz)C+1 • Logarithmic: u(z) = ln(A + Bz) A • Negative exponential: u(z) = − B exp{Bz} where A, B and C are chosen to guarantee u0 > 0, u00 < 0. i.e. marginal utility satisfies u0 (z) = (A + Bz)C or u0 (z) = A exp{Bz} (6.3.23) where A, B and C are again chosen to guarantee u0 > 0, u00 < 0.


pages: 176 words: 55,819

The Start-Up of You by Reid Hoffman

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Airbnb, Andy Kessler, Black Swan, business intelligence, Cal Newport, Clayton Christensen, David Brooks, Donald Trump, en.wikipedia.org, fear of failure, follow your passion, future of work, game design, Jeff Bezos, job automation, late fees, Mark Zuckerberg, Menlo Park, out of africa, Paul Graham, Peter Thiel, recommendation engine, Richard Bolles, risk tolerance, rolodex, shareholder value, side project, Silicon Valley, Silicon Valley startup, social web, Steve Jobs, Steve Wozniak, Tony Hsieh, transaction costs

Just as financial advisors counsel young people to invest in stocks more than bonds, it’s important to be especially aggressive accepting career risk when you are young. This is a main reason many young people start companies, travel around the world, and do other relatively “high-risk” career moves: the downside is lower. If something worthwhile will be riskier in five years than it is now, be more aggressive about taking it on now. As you age and build more assets, your risk tolerance shifts. Pursue Opportunities Where Others Misperceive the Risk There will be times when what’s risky to someone else is not risky to you because your particular characteristics and circumstances make it a different analysis. Risk is personal. But there will also be times when people like you—people with similar assets, aspirations, and operating within the same market realities—will perceive something as riskier than it actually is.


pages: 483 words: 141,836

Red-Blooded Risk: The Secret History of Wall Street by Aaron Brown, Eric Kim

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Albert Einstein, algorithmic trading, Asian financial crisis, Atul Gawande, backtesting, Basel III, Benoit Mandelbrot, Bernie Madoff, Black Swan, capital asset pricing model, central bank independence, Checklist Manifesto, corporate governance, credit crunch, Credit Default Swap, disintermediation, distributed generation, diversification, diversified portfolio, Emanuel Derman, Eugene Fama: efficient market hypothesis, experimental subject, financial innovation, illegal immigration, implied volatility, index fund, Long Term Capital Management, loss aversion, margin call, market clearing, market fundamentalism, market microstructure, money: store of value / unit of account / medium of exchange, moral hazard, natural language processing, open economy, pre–internet, quantitative trading / quantitative finance, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, special drawing rights, statistical arbitrage, stochastic volatility, The Myth of the Rational Market, too big to fail, transaction costs, value at risk, yield curve

However, it could not achieve its full power until it was linked with Markowitz’s work, something that did not happen until the late 1980s. This chapter explains the two ideas and their interaction in a historical counterfactual. What if Kelly had been in the University of Chicago library one fateful afternoon when Harry was musing over some stock tables? What if Harry had met Kelly? Kelly Conventional wisdom says risk decisions should be made by subjective preference: your risk tolerance or your utility function. But in 1956, John Kelly published a contrary result: that there is a calculable amount of risk that always does best in the long run. Most people think that taking more risk increases the probability of both very good and very bad outcomes. Kelly showed that beyond a certain point, more risk only increases the probability of bad outcomes. Moreover, taking less than optimal risk actually guarantees doing worse in the long run; it only appears to be a safer course.

A Sharpe ratio of 0.1 produces a 1 percent excess return; a Sharpe ratio of 0.2 gives about 4 percent; a Sharpe ratio of 0.5 gives about 25 percent. Since the high Sharpe ratio strategies have limited capacity but grow so quickly that initial investment is almost irrelevant, they are appropriate for people investing their own money. Sharpe ratios around 0.5 make good hedge fund strategies. The lower Sharpe ratios are useful for large institutions with cheap capital and high risk tolerance. Card counters gravitated to very high Sharpe ratio strategies. When I say these have limited capacity, I don’t mean there are always opportunities to invest a small amount in them. More commonly, opportunities come up unpredictably. For that reason the strategies are sometimes referred to as “event driven.” They require a lot of investment in time and money to prepare. You can make this large investment to be ready to exploit the strategy, and then wait for years during which no appropriate opportunities come up.


pages: 212 words: 70,224

How to Retire the Cheapskate Way by Jeff Yeager

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asset allocation, car-free, employer provided health coverage, estate planning, financial independence, fixed income, pez dispenser, rent control, ride hailing / ride sharing, risk tolerance, Ronald Reagan, Zipcar

There are four aspects to this rule: Develop a proclivity for safe(r) investments over more risky ones. After all, if you can live comfortably on less money, you don’t need to gamble so aggressively on high-risk investments. The preservation of capital becomes the overriding consideration. Create an individualized asset allocation plan, a plan for what types of investments make sense for you and involve whatever level of risk you can tolerate and still sleep well at night. Remember, in the very act of diversification there is, almost without exception, greater security. “Ton-tog-an-y. Isn’t that Lakota for ‘Don’t put all your eggs in one basket’?” Maintain appropriate insurances to protect yourself and your assets. Take care of your stuff. Investing time and money to maintain the possessions you already own—from your house and car, to your wardrobe and the kids’ bicycles—is one of the best investments you can make. 4.

That’s when I started to think of it as ‘making at a living’ … starting small, risking nothing but my time, and not worrying about whether I’d ever earn a nickel at it. It was the most refreshing, exciting feeling,” Dan says, adding with a quick smile, “but then again, I was an accountant for almost forty years, so I’m easily excited.” With “an investment of absolute zero … just my level of risk tolerance,” Dan relied on word of mouth and a few flyers posted in businesses around the neighborhood to advertise his pet sitting and pet walking services. “To be honest with you, at first I felt a little silly doing it … like a sixty-year old kid starting a lemonade stand. I was thinking I might get a call or two out of it, but that would be about it.” Well, in fact, Dan got seven calls, and that was just in the first two days of announcing his selfish employment venture.


pages: 318 words: 77,223

The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse by Mohamed A. El-Erian

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Airbnb, balance sheet recession, bank run, barriers to entry, Bretton Woods, British Empire, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, collapse of Lehman Brothers, corporate governance, currency peg, Erik Brynjolfsson, eurozone crisis, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, Flash crash, forward guidance, friendly fire, full employment, future of work, Hyman Minsky, If something cannot go on forever, it will stop, income inequality, inflation targeting, Jeff Bezos, Kenneth Rogoff, Khan Academy, liquidity trap, Martin Wolf, megacity, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, oil shale / tar sands, price stability, principal–agent problem, quantitative easing, risk tolerance, risk-adjusted returns, risk/return, Second Machine Age, secular stagnation, sharing economy, sovereign wealth fund, The Great Moderation, The Wisdom of Crowds, too big to fail, University of East Anglia, yield curve

Many, including the least creditworthy ones that could ill afford commercial borrowing terms, were tempted by the easy availability of debt financing as creditors rushed to provide financing at ever more lenient terms. With the private sector credit factories working at feverish levels of activity, the notion of proper creditworthiness analysis gave way to an emphasis on driving lending volumes ever higher. As such, a crazy culture of risk tolerance and spread convergence took hold. Even the worst-managed countries found themselves able to access large loans on terms (interest rate and maturity) that no longer diverged materially from those offered to the best-managed ones (Figure 1, illustrating the extent to which the spread on Greek bonds relative to German ones was compressed for many years). (Data from Thomson Reuters) Figure 1.


pages: 669 words: 210,153

Tools of Titans: The Tactics, Routines, and Habits of Billionaires, Icons, and World-Class Performers by Timothy Ferriss

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Airbnb, artificial general intelligence, asset allocation, Atul Gawande, augmented reality, back-to-the-land, Bernie Madoff, Bertrand Russell: In Praise of Idleness, Black Swan, blue-collar work, Buckminster Fuller, business process, Cal Newport, call centre, Checklist Manifesto, cognitive bias, cognitive dissonance, Colonization of Mars, Columbine, correlation does not imply causation, David Brooks, David Graeber, diversification, diversified portfolio, Donald Trump, effective altruism, Elon Musk, fault tolerance, fear of failure, Firefox, follow your passion, future of work, Google X / Alphabet X, Howard Zinn, Hugh Fearnley-Whittingstall, Jeff Bezos, job satisfaction, Johann Wolfgang von Goethe, Kevin Kelly, Kickstarter, Lao Tzu, life extension, Mahatma Gandhi, Mark Zuckerberg, Mason jar, Menlo Park, Mikhail Gorbachev, Nicholas Carr, optical character recognition, PageRank, passive income, pattern recognition, Paul Graham, Peter H. Diamandis: Planetary Resources, Peter Singer: altruism, Peter Thiel, phenotype, post scarcity, premature optimization, QWERTY keyboard, Ralph Waldo Emerson, Ray Kurzweil, recommendation engine, rent-seeking, Richard Feynman, Richard Feynman, risk tolerance, Ronald Reagan, sharing economy, side project, Silicon Valley, skunkworks, Skype, Snapchat, social graph, software as a service, software is eating the world, stem cell, Stephen Hawking, Steve Jobs, Stewart Brand, superintelligent machines, Tesla Model S, The Wisdom of Crowds, Thomas L Friedman, Wall-E, Washington Consensus, Whole Earth Catalog, Y Combinator

You limit angel investment funds to 10 to 15% or less of your liquid assets. I subscribe to the Nassim Taleb “barbell” school of investment, which I implement as 90% in conservative asset classes like cash-like equivalents and the remaining 10% in speculative investments that can capitalize on positive “black swans.” Even if the above criteria are met, people overestimate their risk tolerance. Even if you have only $100 to invest, this is important to explore. In 2007, I had one wealth manager ask me, “What is your risk tolerance?” and I answered honestly: “I have no idea.” It threw him off. I then asked him for the average of his clients’ responses. He said, “Most answer that they would not panic up to about 20% down in one quarter.” My follow-up question was: “When do most actually panic and start selling low?” His answer: “When they’re down 5% in one quarter.”

They’re attractive for many reasons: developing new business skills, developing a better business network, or—most often—taking what is effectively a 2-year vacation that looks good on a résumé. In 2001, and again in 2004, I wanted to do all three things. This short chapter will share my experience with MBA programs and how I created my own. My hope is that it will make you think about real-world experiments versus theoretical training, untested assumptions (especially about risk tolerance), and the good game of business as a whole. There is no need to spend $60K per year to apply the principles I’ll be discussing. Last caveat: Nothing here is intended to portray me as an investing expert, which I am not. Beginnings * * * Ah, Stanford Graduate School of Business (GSB). Stanford, with its palm tree–lined avenues and red terra cotta roofing, always held a unique place in my mind.


pages: 464 words: 117,495

The New Trading for a Living: Psychology, Discipline, Trading Tools and Systems, Risk Control, Trade Management by Alexander Elder

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additive manufacturing, Atul Gawande, backtesting, Benoit Mandelbrot, buy low sell high, Checklist Manifesto, deliberate practice, diversification, Elliott wave, endowment effect, loss aversion, mandelbrot fractal, margin call, offshore financial centre, paper trading, Ponzi scheme, price stability, psychological pricing, quantitative easing, random walk, risk tolerance, short selling, South Sea Bubble, systematic trading, The Wisdom of Crowds, transaction costs, transfer pricing, traveling salesman, tulip mania

We'll focus on risk and money management in a later chapter when I discuss the concept of “The Iron Triangle of risk control.” At this point, I only want to make clear that risk management is the essential part of serious trading. Forget the days when you would look at the ceiling and say, “I'll trade 500 shares,” “I'll trade a thousand shares,” or any other arbitrary number. Later in this book, you'll learn a simple formula for sizing your trades, based on your account and risk tolerance. At the time of this writing, I have three strategies that I trade. My favorite is a false breakout with a divergence. My second choice is a pullback to value during a powerful trend—that's the strategy of the trade shown on the screen (Figure 38.1). Last, I occasionally “fade an extreme”—bet on a reversal of an overstretched trend. Each of these strategies has its rules, but the key point is this—I'll only take a trade that fits one of them.

Decide in advance what percentage you'll protect. For example, you may decide that once the breakeven stop is in place, you'll protect a third of your open profit. If the open profit on the trade described above rises to $600, you'll move up your stop, so that the $200 profit is protected. These levels aren't set in stone. You may choose different percentages, depending on your level of confidence in a trade and risk tolerance. As a trade moves in your favor, your remaining potential gain begins to shrink, while your risk—the distance to the stop—keeps increasing. To trade is to manage risk. As the reward-to-risk ratio for your winning trades slowly deteriorates, you need to begin reducing your risk. Protecting a portion of your paper profits will keep your reward-to-risk ratio on a more even keel. Move Your Stop Only in the Direction of Your Trade You buy a stock and, being a disciplined trader, put a stop underneath.

Investment: A History by Norton Reamer, Jesse Downing

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Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Berlin Wall, Bernie Madoff, Brownian motion, buttonwood tree, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, Gordon Gekko, Henri Poincaré, high net worth, index fund, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, means of production, Menlo Park, merger arbitrage, moral hazard, mortgage debt, Network effects, new economy, Nick Leeson, Own Your Own Home, pension reform, Ponzi scheme, price mechanism, principal–agent problem, profit maximization, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sand Hill Road, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, technology bubble, The Wealth of Nations by Adam Smith, time value of money, too big to fail, transaction costs, underbanked, Vanguard fund, working poor, yield curve

However, in the following decades, many employers shifted away from defined benefit plans and toward defined contribution plans. By the end of 2012, defined contribution plans held $5.1 trillion in assets.5 These plans, such as 401(k) plans, 403(b) plans, and 457 plans, are not managed by a single sponsor managing one fund. Instead, each employee controls his or her own account; the individual makes allocation decisions in accordance with his or her own risk tolerance and savings needs. This mitigates the risks associated with unfunded pension liabilities in many defined benefit plans, but it shifts the risk of investment loss and the management of the New Clients and New Investments 123 assets to the beneficiary. Very likely defined contribution plans will continue to be the employers’ retirement plan of choice because then employers are able to avoid the liabilities and risks associated with defined benefit plans.

Asian sovereign wealth funds, by contrast, have foreign reserves due to positive trade balances as their source; thus their focus is more about diversifying away from the currency price risk to which they are exposed.33 The investment strategies of sovereign wealth funds also tend to align with the fundamental reasons for their creation. Most sovereign wealth funds tend to be slightly more interested in capital preservation, whereas ones that are centrally concerned with growing the assets often have a slightly higher risk tolerance. But in general, New Clients and New Investments 131 sovereign wealth funds are widely diversified and can manage a wide liquidity spectrum, since they do not have explicitly dated liabilities. Given the historical trend and the broadening of the conviction in the merits of these funds, the future seems bright for sovereign wealth funds. They are likely to become more plentiful as countries seek to monetize their resources, diversify away risk, and orient the revenue of the country toward a wider stream of income sources.


pages: 407 words: 109,653

Top Dog: The Science of Winning and Losing by Po Bronson, Ashley Merryman

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Asperger Syndrome, Berlin Wall, conceptual framework, crowdsourcing, delayed gratification, deliberate practice, Edward Glaeser, experimental economics, Fall of the Berlin Wall, fear of failure, game design, Jean Tirole, knowledge worker, loss aversion, Mark Zuckerberg, meta analysis, meta-analysis, Mikhail Gorbachev, phenotype, Richard Feynman, Richard Feynman, risk tolerance, school choice, shareholder value, Silicon Valley, six sigma, Steve Jobs

Puxeddu, R. Anand, L. Cascarini, J. S. Brown, C. M. Avery, R. T. M. Woodwards, & D. A. Mitchell, “Serum Testosterone Levels in Surgeons during Major Head and Neck Cancer Surgery: A Suppositional Study,” British Journal of Oral & Maxillofacial Surgery, vol. 49(3), pp. 190–193 (2011) Carney, Dana R., Amy J. C. Cudy, & Andy J. Yap, “Power Posing: Brief Nonverbal Displays Affect Neuroendocrine Levels and Risk Tolerance,” Psychological Science, vol. 21(10), pp. 1363–1368 (2010) Carré, Justin M., Jenna D. Gilchrist, Mark D. Morrissey, & Cheryl M. McCormick, “Motivational and Situational Factors and the Relationship between Testosterone Dynamics and Human Aggression during Competition,” Biological Psychology, vol. 84(2), pp. 346–353 (2010) Carré, Justin M., & Pranjal J. Mehta, “Importance of Considering Testosterone–Cortisol Interactions in Predicting Human Aggression and Dominance,” Aggressive Behavior, vol. 37(6), pp. 489–491 (2011) Carré, Justin M., Susan K.

The Handbook of Personal Wealth Management by Reuvid, Jonathan.

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asset allocation, banking crisis, BRICs, collapse of Lehman Brothers, correlation coefficient, credit crunch, cross-subsidies, diversification, diversified portfolio, estate planning, financial deregulation, fixed income, high net worth, income per capita, index fund, interest rate swap, laissez-faire capitalism, land tenure, market bubble, merger arbitrage, new economy, Northern Rock, pattern recognition, Ponzi scheme, prediction markets, risk tolerance, risk-adjusted returns, risk/return, short selling, side project, sovereign wealth fund, statistical arbitrage, systematic trading, transaction costs, yield curve

Investors’ goals and aspirations, as well as their immediate and longer-term needs, should of course be fully appreciated, but an investor profile should also include insight into the boundaries at which their comfort with risk is drawn. Profiling the investor should not be an afterthought. Any assessment that falls short is fruitless, not to be mention potentially damaging to the attainment of the investor’s financial targets. The primary profiling considerations are summarized in Figure 1.1.2. ឣ 10 PORTFOLIO INVESTMENT _________________________________________________ Investors risk tolerances Tolerance to loss of capital Volatility (ability to withstand fluctuations in returns) Return objectives Return target over specified time frame Time horizon Time expectation for goal achievement Income The requirement for cash flow (coupons, dividends) Could be tied to liability management Liquidity requirements and illiquidity tolerance Tolerance to illiquidity Consideration to future portfolio evolution/cash needs Currency Base currency or basket of currencies reference Hedging requirements Taxation considerations/advice being taken Specific areas of awareness – universe restrictions Capital vs income return derivation Further preferences and constraints Specific/important/ancillary information Source: Citi Private Bank Figure 1.1.2 Profiling considerations A well-constructed portfolio plan is the end result of extensive profiling and holistic review.


pages: 225 words: 11,355

Financial Market Meltdown: Everything You Need to Know to Understand and Survive the Global Credit Crisis by Kevin Mellyn

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asset-backed security, bank run, banking crisis, Bernie Madoff, bonus culture, Bretton Woods, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, disintermediation, diversification, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Francis Fukuyama: the end of history, global reserve currency, Home mortgage interest deduction, Isaac Newton, joint-stock company, liquidity trap, London Interbank Offered Rate, margin call, market clearing, moral hazard, mortgage tax deduction, Northern Rock, offshore financial centre, paradox of thrift, pattern recognition, pension reform, pets.com, Plutocrats, plutocrats, Ponzi scheme, profit maximization, pushing on a string, reserve currency, risk tolerance, risk-adjusted returns, road to serfdom, Ronald Reagan, shareholder value, Silicon Valley, South Sea Bubble, statistical model, The Great Moderation, the payments system, too big to fail, value at risk, very high income, War on Poverty, Y2K, yield curve

History has not ended, it has been rewound to the 1970s and before, all the way back to the post-war socialist consensus that lonely voices like Ayn Rand railed against. YOU AND YOUR MONEY This brings us back to you and your money. The balance of risk and return in a market can be reasonably gauged when the rules are known. We can’t anticipate exactly what the market will do tomorrow, but we can hedge our bets and act on our own risk tolerance. We Conclusion can make our own decisions like grown-ups and take responsibility for the ones that go wrong. If something sounds too good to be true, it probably is, and those who are not skeptical of the claims of financial professionals can end up at the wrong end of a Ponzi scheme or an exploding interest-only mortgage. However, nobody is compelled to do anything. Markets are about choice.


pages: 236 words: 77,735

Rigged Money: Beating Wall Street at Its Own Game by Lee Munson

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affirmative action, asset allocation, backtesting, barriers to entry, Bernie Madoff, Bretton Woods, buy low sell high, California gold rush, call centre, Credit Default Swap, diversification, diversified portfolio, estate planning, fiat currency, financial innovation, fixed income, Flash crash, follow your passion, German hyperinflation, High speed trading, housing crisis, index fund, joint-stock company, moral hazard, passive investing, Ponzi scheme, price discovery process, random walk, risk tolerance, risk-adjusted returns, risk/return, too big to fail, trade route, Vanguard fund, walking around money

Why not sell that broad-based mutual fund and get with blue chip dividend payers? Let’s not even get into the world of commodities or complex strategies. If the industry can convince you only to think of the asset class’s expected return, you are then tuned into their prognostications of what those returns will be. The pie chart is just the delivery system, like a cigarette. Now, with your handy little allocation and risk tolerance given to you by a trusted adviser, you are free to roam the garbage dumps of Wall Street noise to find your golden goose. Will it be Eastern Europe that boosts your returns this year, or perhaps a bet on China? What would otherwise look like reckless abandon is now fully sanctioned by Wall Street. You have a pie chart, so why worry? I will tell you why to worry: Risk, correlation, and the false sense of security that you can drop anything into your pie chart as long as the asset class matches the slot.


pages: 272 words: 64,626

Eat People: And Other Unapologetic Rules for Game-Changing Entrepreneurs by Andy Kessler

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23andMe, Andy Kessler, bank run, barriers to entry, Berlin Wall, British Empire, business process, California gold rush, carbon footprint, Cass Sunstein, cloud computing, collateralized debt obligation, collective bargaining, computer age, disintermediation, Eugene Fama: efficient market hypothesis, fiat currency, Firefox, Fractional reserve banking, George Gilder, Gordon Gekko, greed is good, income inequality, invisible hand, James Watt: steam engine, Jeff Bezos, job automation, Joseph Schumpeter, knowledge economy, knowledge worker, libertarian paternalism, low skilled workers, Mark Zuckerberg, McMansion, Netflix Prize, packet switching, personalized medicine, pets.com, prediction markets, pre–internet, profit motive, race to the bottom, Richard Thaler, risk tolerance, risk-adjusted returns, Silicon Valley, six sigma, Skype, social graph, Steve Jobs, The Wealth of Nations by Adam Smith, transcontinental railway, transfer pricing, Yogi Berra

If you don’t have enough, you need to attract it, like my Net Net example raising capital and going public. But how? Fortunately, money sloshes around the globe seeking its highest return. To be a true Free Radical, be the highest return. Money goes wherever it damn pleases. Moving around the globe, pulsing through electronic networks and bank databases, seeking to maximize its risk-adjusted return. Maybe someone’s risk tolerance is low so they invest their money in U.S. Treasury Bills. So be it. Others (like me) think that teams of smart people inventing the future are actually less risky than big corporations that are or will soon be under attack from these entrepreneurs, so I invest in small companies and start-ups. That’s me and my money’s prerogative. Others are even more daring and invest in Estonia or the Congo or even Venezuela, places with potentially high returns but huge political or physical risks.


pages: 280 words: 79,029

Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better by Andrew Palmer

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Affordable Care Act / Obamacare, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, Black-Scholes formula, bonus culture, Bretton Woods, call centre, Carmen Reinhart, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Graeber, diversification, diversified portfolio, Edmond Halley, Edward Glaeser, Eugene Fama: efficient market hypothesis, eurozone crisis, family office, financial deregulation, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, implied volatility, income inequality, index fund, Innovator's Dilemma, interest rate swap, Kenneth Rogoff, Kickstarter, late fees, London Interbank Offered Rate, Long Term Capital Management, loss aversion, margin call, Mark Zuckerberg, McMansion, mortgage debt, mortgage tax deduction, Network effects, Northern Rock, obamacare, payday loans, peer-to-peer lending, Peter Thiel, principal–agent problem, profit maximization, quantitative trading / quantitative finance, railway mania, randomized controlled trial, Richard Feynman, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

That night the disgruntled gang members seized Oldfield and bundled him into a small, enclosed square in central Moscow, where they fired bullets into the earth around his feet. He escaped by jumping a wall topped with razor wire—and still has the scars on his hand and leg to prove it. The aim was to scare him, not kill him. “They succeeded,” he says ruefully. Oldfield abandoned his Russian adventure and headed back to London. That first abrupt experience gave him a feel for his own levels of risk tolerance. It also educated him on how mortgage markets in general work. One feature of the housing-finance market in particular bothered him: home ownership requires both the borrowers and the lenders to take on an awful lot of risk. Borrowers must face up to the possibility of unemployment, negative equity, and rising interest rates; lenders must cope with the threat of defaulting borrowers and declining asset values.


pages: 214 words: 71,585

Selfish, Shallow, and Self-Absorbed: Sixteen Writers on the Decision Not to Have Kids by Meghan Daum

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delayed gratification, demographic transition, Donald Trump, financial independence, happiness index / gross national happiness, index card, Mason jar, peak oil, Ponzi scheme, risk tolerance, Skype, women in the workforce

My partner knew well what I had discovered about nicotine and pregnancy. She knew everything that I (and science) knew about prenatal drug abuse. But she scoffed when I reminded her. She also knew what Hugh Laurie’s character had said in nearly every episode of House: “Everybody lies.” And addicts lie the most. Some people are energized by risk. There’s no reason why they shouldn’t be. But in a relationship, the risk tolerance of partners should match. To draw upon the wisdom of Aesop, ants should not marry grasshoppers. I am an unglamorous ant—deferring gratification, socking away money religiously and investing it prudently. My partner was a grasshopper—seeking what she wants when she wants it, unconcerned by the threat of a rainy day. I suspect that when she flew from Los Angeles to meet the pregnant woman, she was fueled as much by risk as by her urge to be a mother.


pages: 326 words: 74,433

Do More Faster: TechStars Lessons to Accelerate Your Startup by Brad Feld, David Cohen

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augmented reality, computer vision, corporate governance, crowdsourcing, disintermediation, hiring and firing, Inbox Zero, Jeff Bezos, knowledge worker, Lean Startup, Ray Kurzweil, recommendation engine, risk tolerance, Silicon Valley, Skype, slashdot, social web, software as a service, Steve Jobs

It is very likely that one or more co-founders will be putting in some cash in the early stages of the company. It is critical to decide up front how this cash will be treated. Is it debt? Is it convertible debt? Does it buy a different class of shares? What happens if the company raises follow-on funding? What will we pay ourselves? Who gets to change this in the future? This can be a touchy issue. Risk tolerance varies by individual and it is a good idea to factor this into determining the compensation plan for the founders. The issue can be clouded sometimes when one of the founders is investing significant cash into the enterprise. What are the financing plans for the company? Will the company be self-funded and bootstrapped? Raise angel funding? Raise venture capital funding? What happens if this doesn't occur?


pages: 224 words: 13,238

Electronic and Algorithmic Trading Technology: The Complete Guide by Kendall Kim

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algorithmic trading, automated trading system, backtesting, corporate governance, Credit Default Swap, diversification, en.wikipedia.org, family office, financial innovation, fixed income, index arbitrage, index fund, interest rate swap, linked data, market fragmentation, natural language processing, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, short selling, statistical arbitrage, Steven Levy, transaction costs, yield curve

Predictability The degree of predictability governs the degree to which horizon and schedule should be implemented. This consideration requires the use of properties of the distribution estimates, in addition to averages, such as standard deviation measures. 4. Price sensitivity As price sensitivity increases, structure becomes less useful, due to the need to advertise willingness to trade. Short-term volatility history and real-time deviation are inputs along the dimension. 5. Risk tolerance Refers to execution risks versus the benchmark. Greater tolerance generates less need for a structured horizon and schedule. Pre-trade information can map out optimal tradeoffs between risk, cost, and alpha for varying trade horizons.2 6.3 Algorithmic Feasibility Not all trade orders are suitable for an algorithmic strategy. Two questions must be answered before any further consideration for analysis 2 Ian Domowitz and Henry Yegerman, ‘‘Measuring and Interpreting the Performance of Broker Algorithms,’’ in Algorithmic Trading: A Buy-Side Handbook, 67–70 (London: The Trade Ltd., 2005).


pages: 353 words: 81,436

Buying Time: The Delayed Crisis of Democratic Capitalism by Wolfgang Streeck

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banking crisis, Bretton Woods, capital controls, Carmen Reinhart, central bank independence, collective bargaining, corporate governance, David Graeber, deindustrialization, Deng Xiaoping, Eugene Fama: efficient market hypothesis, financial deregulation, financial repression, full employment, Gini coefficient, Growth in a Time of Debt, income inequality, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, labour market flexibility, labour mobility, late capitalism, means of production, moral hazard, Occupy movement, open borders, open economy, Plutonomy: Buying Luxury, Explaining Global Imbalances, profit maximization, risk tolerance, shareholder value, too big to fail, union organizing, winner-take-all economy, Wolfgang Streeck

That price – of labour-power as a commodity – is independent of the profit that may or may not be obtained from its deployment. In the psychologistic worldview of labour economics, the distinction between residual capital income and contractually fixed labour income – between profits and wages – is associated with different ‘risk propensities’: ‘risk-averse’ individuals prefer to be workers, with a low but secure labour income, while the more ‘risk-tolerant’ become entrepreneurs, with a less secure but potentially high capital income. Whereas recipients of residual income seek the highest possible yield on their capital investment, earners of fixed income try to keep as low as possible the input required of them.41 Distribution conflicts arise from the fact that, other things being equal, higher residual income for the profit-dependent entails lower wages for the wage-dependent, and vice versa.42 For a theory of political economy in which capital is an actor and not just machinery, the seemingly technical ‘functioning’ of the ‘economy’ – above all, growth and full employment – is in reality a political matter.

Evidence-Based Technical Analysis: Applying the Scientific Method and Statistical Inference to Trading Signals by David Aronson

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Albert Einstein, Andrew Wiles, asset allocation, availability heuristic, backtesting, Black Swan, capital asset pricing model, cognitive dissonance, compound rate of return, Daniel Kahneman / Amos Tversky, distributed generation, Elliott wave, en.wikipedia.org, feminist movement, hindsight bias, index fund, invention of the telescope, invisible hand, Long Term Capital Management, mental accounting, meta analysis, meta-analysis, p-value, pattern recognition, Ponzi scheme, price anchoring, price stability, quantitative trading / quantitative finance, Ralph Nelson Elliott, random walk, retrograde motion, revision control, risk tolerance, risk-adjusted returns, riskless arbitrage, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, statistical model, systematic trading, the scientific method, transfer pricing, unbiased observer, yield curve, Yogi Berra

It is far more realistic to assume a world of investors with highly diverse attitudes toward risk. In such a world, some investors would be more adverse to risk than others, and they would be willing to pay other investors to accept the burden of additional risk. Also, there would likely be risk-tolerant investors looking to profit from the opportunity to assume additional risk. All that would be needed in such a world is a mechanism by which risk can be transferred from the risk adverse to the risk tolerant and for compensation to be paid to those willing to accept said risk. Let’s step away from markets for a moment to consider one mechanism by which the risk adverse can compensate the risk inclined—the insurance premium. Homeowners dread the possibility of a fire, so they enter into a transaction with a fire insurance company.


pages: 496 words: 154,363

I'm Feeling Lucky: The Confessions of Google Employee Number 59 by Douglas Edwards

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Albert Einstein, AltaVista, Any sufficiently advanced technology is indistinguishable from magic, barriers to entry, book scanning, Build a better mousetrap, Burning Man, business intelligence, call centre, crowdsourcing, don't be evil, Elon Musk, fault tolerance, Googley, gravity well, invisible hand, Jeff Bezos, job-hopping, Menlo Park, microcredit, music of the spheres, Network effects, P = NP, PageRank, performance metric, pets.com, Ralph Nader, risk tolerance, second-price auction, side project, Silicon Valley, Silicon Valley startup, slashdot, stem cell, Superbowl ad, Y2K

To allow the publication of unscreened ads was a classic marketing crisis in the making. Any fool could see that. Evidently, I was that fool. Others shared my incredulity. One engineer was so appalled by the plan that he considered writing a letter to the VCs on the board informing them we were about to lose all the money they had invested in us. Chad Lester—the omnivore engineer—however, celebrated our founder's risk tolerance. "I was excited about it," Chad told me after the fact. "It was like high school and TP-ing someone's house. Why not try it and see what happens?" I'd seen managers build consensus before moving ahead with unpopular decisions, and I knew bosses who dipped their toes in untested waters, fully prepared to pull out quickly if the temperature rose above or dropped below their comfort level. This was a different kind of leadership.


pages: 272 words: 19,172

Hedge Fund Market Wizards by Jack D. Schwager

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asset-backed security, backtesting, banking crisis, barriers to entry, Bernie Madoff, Black-Scholes formula, British Empire, Claude Shannon: information theory, cloud computing, collateralized debt obligation, commodity trading advisor, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, diversification, diversified portfolio, family office, financial independence, fixed income, Flash crash, hindsight bias, implied volatility, index fund, James Dyson, Long Term Capital Management, margin call, market bubble, market fundamentalism, merger arbitrage, oil shock, pattern recognition, pets.com, Ponzi scheme, private sector deleveraging, quantitative easing, quantitative trading / quantitative finance, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Sharpe ratio, short selling, statistical arbitrage, Steve Jobs, systematic trading, technology bubble, transaction costs, value at risk, yield curve

In reality, the entry size is often more important than the entry price because if the size is too large, a trader will be more likely to exit a good trade on a meaningless adverse price move. The larger the position, the greater the danger that trading decisions will be driven by fear rather than by judgment and experience. According to Clark, one way of knowing your position is too large is if you wake up thinking about it. You also need to be sure that your methodology is consistent with your risk tolerance. For example, if your trade implementation strategy allows for building a three-unit position, but your natural risk tolerance is only one unit, you can easily end up panicking out of good positions because you are trading larger than your comfort level. Trading size needs to be kept small enough so that fear does not become the prevailing instinct guiding your judgment. As Clark says, you have to “trade within your emotional capacity.” Position size is important not only in avoiding trading too large, but also in trading larger when warranted.

The Age of Turbulence: Adventures in a New World (Hardback) - Common by Alan Greenspan

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air freight, airline deregulation, Albert Einstein, asset-backed security, bank run, Berlin Wall, Bretton Woods, business process, call centre, capital controls, central bank independence, collateralized debt obligation, collective bargaining, conceptual framework, Corn Laws, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cuban missile crisis, currency peg, Deng Xiaoping, Dissolution of the Soviet Union, Doha Development Round, double entry bookkeeping, equity premium, everywhere but in the productivity statistics, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, full employment, Gini coefficient, Hernando de Soto, income inequality, income per capita, invisible hand, Joseph Schumpeter, labor-force participation, labour market flexibility, laissez-faire capitalism, land reform, Long Term Capital Management, Mahatma Gandhi, manufacturing employment, market bubble, means of production, Mikhail Gorbachev, moral hazard, mortgage debt, new economy, North Sea oil, oil shock, open economy, pets.com, Potemkin village, price mechanism, price stability, Productivity paradox, profit maximization, purchasing power parity, random walk, reserve currency, risk tolerance, Ronald Reagan, shareholder value, short selling, Silicon Valley, special economic zone, the payments system, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, total factor productivity, trade liberalization, trade route, transaction costs, transcontinental railway, urban renewal, working-age population, Y2K

Take the United States and France, for example, both of whose most fundamental values are rooted in the Enlightenment. A recent poll shows that 71 percent of Americans agree that the free-market system is the best economic system available. Only 36 percent of the French agree. Another poll indicates that three-fourths of young French men and women aspire to a job in government. Few young Americans express that preference. Such numbers speak to a remarkable difference in risk tolerance. The French are far less inclined to suffer the competitive pressures of a free market and overwhelmingly seek the security of a government job, despite the widespread evidence that risk taking is essential for economic growth. I can't say the greater the risk taking, the greater the rate of growth. Obviously, reckless gambling rarely pays off in the end. The risk taking I have in mind is the rationally calculated kind of most business judgments.

Spreads of emerging-market bond yields over those of U.S. treasuries have declined from 10 percentage points in 2002 to less than IVz percentage points in June 2007. This compression of risk premiums is global. I am uncertain whether in periods of euphoria people reach for an amount of risk that is at the outer limits of human tolerance, irrespective of the institutional environment in which they live. The prevailing financial infrastructure perhaps merely leverages this risk tolerance. For decades prior to the Civil War, banks had to hold capital well in excess of 40 percent to secure their notes and deposits. By 1900, national banks' capital cover was down to 20 percent of assets, to 12 percent by 1925, and below 10 percent in recent years. But owing to financial flexibility and far greater sources of liquidity, the fundamental risk borne by the individual banks, and presumably investors generally, may not have changed much over that time period.


pages: 322 words: 107,576

Bad Science by Ben Goldacre

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Asperger Syndrome, correlation does not imply causation, experimental subject, Ignaz Semmelweis: hand washing, John Snow's cholera map, Louis Pasteur, meta analysis, meta-analysis, offshore financial centre, p-value, placebo effect, Richard Feynman, Richard Feynman, risk tolerance, Ronald Reagan, the scientific method, urban planning

But it is also expensive: one session of Aqua Detox will cost more man the components to build your own detox device, a perfect model of the real one. You will need: One car battery charger Two large nails Kitchen salt Warm water One Barbie doll A full analytic laboratory (optional) This experiment involves electricity and water. In a world of hurricane hunters and volcanologists, we must accept that everyone sets their own level of risk tolerance. You might well give yourself a nasty electric shock if you perform this experiment at home, and it could easily blow the wiring in your house. It is not safe, but it is in some sense relevant to your understanding of MMR, homeopathy, post-modernist critiques of science and the evils of big pharma. Do not build it. When you switch your Barbie Detox machine on, you will see that the water goes brown, due to a very simple process called electrolysis: the iron electrodes rust, essentially, and the brown rust goes into the water.


pages: 342 words: 94,762

Wait: The Art and Science of Delay by Frank Partnoy

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algorithmic trading, Atul Gawande, Bernie Madoff, Black Swan, blood diamonds, Cass Sunstein, Checklist Manifesto, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, Daniel Kahneman / Amos Tversky, delayed gratification, Flash crash, Frederick Winslow Taylor, George Akerlof, Google Earth, Hernando de Soto, High speed trading, impulse control, income inequality, Isaac Newton, Long Term Capital Management, Menlo Park, mental accounting, meta analysis, meta-analysis, Nick Leeson, paper trading, Paul Graham, payday loans, Ralph Nader, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, six sigma, Spread Networks laid a new fibre optics cable between New York and Chicago, statistical model, Steve Jobs, The Market for Lemons, the scientific method, The Wealth of Nations by Adam Smith, upwardly mobile, Walter Mischel

The brain scans of the subjects showed that they made superficial judgments primarily in the amygdalae, the neural regions that specialize in automatic processing, while individuated judgments were spread around a neural network of several other brain regions. It appears from this research that the amygdalae, though important and useful in numerous ways, also play a major role when we form implicit biases. 33. Dana R. Carney, Amy J. C. Cuddy, and Andy Yap, “Power Posing: Brief Nonverbal Displays Affect Neuroendocrine Levels and Risk Tolerance,” Psychological Science 21(10, 2010): 1363–1368. 34. Ibid., p. 9. Testosterone has been shown to blunt social emotions such as guilt, embarrassment, and anxiety; it makes both men and women feel less empathy. See Erno Jan Hermans, Peter Putman, and Jack van Honk, “Testosterone Administration Reduces Empathetic Behavior: A Facial Mimicry Study,” Psychoneuroendocrinology 31(2006): 859–866; Erno Jan Hermans, Peter Putman, Johanna M.


pages: 292 words: 85,151

Exponential Organizations: Why New Organizations Are Ten Times Better, Faster, and Cheaper Than Yours (And What to Do About It) by Salim Ismail, Yuri van Geest

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23andMe, 3D printing, Airbnb, Amazon Mechanical Turk, Amazon Web Services, augmented reality, autonomous vehicles, Baxter: Rethink Robotics, bioinformatics, bitcoin, Black Swan, blockchain, Burning Man, business intelligence, business process, call centre, chief data officer, Clayton Christensen, clean water, cloud computing, cognitive bias, collaborative consumption, collaborative economy, corporate social responsibility, cross-subsidies, crowdsourcing, cryptocurrency, dark matter, Dean Kamen, dematerialisation, discounted cash flows, distributed ledger, Edward Snowden, Elon Musk, en.wikipedia.org, ethereum blockchain, Galaxy Zoo, game design, Google Glasses, Google Hangouts, Google X / Alphabet X, gravity well, hiring and firing, Hyperloop, industrial robot, Innovator's Dilemma, Internet of things, Iridium satellite, Isaac Newton, Jeff Bezos, Kevin Kelly, Kickstarter, knowledge worker, Kodak vs Instagram, Law of Accelerating Returns, Lean Startup, life extension, loose coupling, loss aversion, Lyft, Mark Zuckerberg, market design, means of production, minimum viable product, natural language processing, Netflix Prize, Network effects, new economy, Oculus Rift, offshore financial centre, p-value, PageRank, pattern recognition, Paul Graham, Peter H. Diamandis: Planetary Resources, Peter Thiel, prediction markets, profit motive, publish or perish, Ray Kurzweil, recommendation engine, RFID, ride hailing / ride sharing, risk tolerance, Ronald Coase, Second Machine Age, self-driving car, sharing economy, Silicon Valley, skunkworks, Skype, smart contracts, Snapchat, social software, software is eating the world, speech recognition, stealth mode startup, Stephen Hawking, Steve Jobs, subscription business, supply-chain management, TaskRabbit, telepresence, telepresence robot, Tony Hsieh, transaction costs, Tyler Cowen: Great Stagnation, urban planning, WikiLeaks, winner-take-all economy, X Prize, Y Combinator

Product management, marketing and sales are often aligned vertically, and support functions such as legal, HR, finance and IT are usually horizontal. So the person handling legal for a product has two reporting lines, one to the head of product, who has revenue accountability, and the other to the head of legal, whose job it is to ensure consistency across numerous products. This is great for command and control, but it’s terrible for accountability, speed and risk tolerance. Every time you try to do something, you have to get authorization from all the muckety-mucks in HR, legal, accounting and so on, which takes time. Another major issue Salim has observed with matrix structures is that, over time, power accrues to the horizontals. Often, HR or legal have no incentive to say yes, so their default answer becomes no (which is why HR is often referred to as “inhuman resources”).


pages: 370 words: 97,138

Beyond: Our Future in Space by Chris Impey

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3D printing, Admiral Zheng, Albert Einstein, Alfred Russel Wallace, Berlin Wall, Buckminster Fuller, butterfly effect, California gold rush, carbon-based life, Colonization of Mars, cosmic abundance, crowdsourcing, cuban missile crisis, dark matter, discovery of DNA, Doomsday Clock, Edward Snowden, Elon Musk, Eratosthenes, Haight Ashbury, Hyperloop, I think there is a world market for maybe five computers, Isaac Newton, Jeff Bezos, John von Neumann, Kickstarter, life extension, Mahatma Gandhi, Mars Rover, mutually assured destruction, Oculus Rift, operation paperclip, out of africa, Peter H. Diamandis: Planetary Resources, phenotype, purchasing power parity, RAND corporation, Ray Kurzweil, RFID, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Search for Extraterrestrial Intelligence, Searching for Interstellar Communications, Silicon Valley, skunkworks, Skype, Stephen Hawking, Steven Pinker, supervolcano, technological singularity, telepresence, telerobotics, the medium is the message, the scientific method, theory of mind, V2 rocket, wikimedia commons, X Prize, Yogi Berra

It’s now an international activity; fewer than half of the satellites launched for commercial use are built in the United States (Figure 34).21 The economic viability of space tourism is difficult to extrapolate—its capabilities aren’t very impressive and its eventual size and long-term future are unclear. A few wealthy individuals have ponied up $20 million for a trip to the International Space Station, and it’s the belief of space visionaries that as the price comes down, the demand will increase. But there are wild cards, such as the risk tolerance of people indulging in a recreation that could lead to a grisly end. The best market study done so far is by the Futron Corporation, an aerospace consulting firm with no skin in the space-tourism game. For orbital trips, they assume that the $20 million price tag will come down to $5 million after twenty years. Revenues would be $300 million at the end of that time frame. For suborbital trips, they assume a price of $100,000, declining to $50,000 after twenty years, when revenue would be a billion dollars a year.22 Surveys of the general public are consistent among industrialized countries; the lure of space knows no borders.


pages: 426 words: 105,423

The 4-Hour Workweek: Escape 9-5, Live Anywhere, and Join the New Rich by Timothy Ferriss

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Albert Einstein, Amazon Mechanical Turk, call centre, clean water, Donald Trump, en.wikipedia.org, Firefox, follow your passion, game design, global village, Iridium satellite, knowledge worker, late fees, Maui Hawaii, oil shock, paper trading, Parkinson's law, passive income, pre–internet, Ralph Waldo Emerson, remote working, Richard Feynman, risk tolerance, Ronald Reagan, side project, Silicon Valley, Silicon Valley startup, Skype, Steve Jobs, wage slave, William of Occam

Logging time as an experiment, I concluded that I often spend at least 50 x more time to prevent a hypothetical unit of $100 from being lost vs. earned. The hysterical part is that, even after becoming aware of this bias, it’s hard to prevent the latter response. Therefore, I manipulate the environmental causes of poor responses instead of depending on error-prone self-discipline. I should not invest in public stocks where I cannot influence outcomes. Once realizing that almost no one can predict risk tolerance and response to losses, I moved all of my investments into fixed-income and cashlike instruments in July 2008 for this reason, setting aside 10% of pretax income for angel investments where I can contribute significant UI/design, PR, and corporate partnership help. (Suggested reading: Rethinking Investing—Part 1, Rethinking Investing—Part 2 on www.fourhourblog.com.) A good question to revisit whenever overwhelmed: Are you having a breakdown or a breakthrough?


pages: 323 words: 92,135

Running Money by Andy Kessler

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Andy Kessler, Apple II, bioinformatics, British Empire, business intelligence, buy low sell high, call centre, Corn Laws, family office, full employment, George Gilder, happiness index / gross national happiness, interest rate swap, invisible hand, James Hargreaves, James Watt: steam engine, joint-stock company, joint-stock limited liability company, knowledge worker, Long Term Capital Management, mail merge, margin call, market bubble, Maui Hawaii, Menlo Park, Network effects, packet switching, pattern recognition, pets.com, railway mania, risk tolerance, Sand Hill Road, Silicon Valley, South China Sea, spinning jenny, Steve Jobs, Steve Wozniak, Toyota Production System

It’s not because we somehow insist on those dollars back or beg for those dollars back; they naturally return. Most of those returning dollars buy U.S. Treasuries, which are backed by the tax payments from the high wages that high-margin businesses pay to programmers and engineers versus low-paid factory workers. So far, so good. Foreigners own something like 45% of all Treasuries, some as reserves for their central banks in lieu of gold. Some of those dollars, which are more risk tolerant, buy corporate debt. But the real smart dollars are invested in the highmargin businesses directly. Those dollars can and do buy Intel stock or Microsoft stock. Directly and indirectly, those dollars invest in a high-margin economy. In fact, when they don’t, and invest at home, they almost always screw up. Not just the bank loan problems of Japan, but witness the Korean mess in 1998, which helped provide an introduction for me to Ssangyong.


pages: 347 words: 97,721

Only Humans Need Apply: Winners and Losers in the Age of Smart Machines by Thomas H. Davenport, Julia Kirby

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AI winter, Andy Kessler, artificial general intelligence, asset allocation, Automated Insights, autonomous vehicles, Baxter: Rethink Robotics, business intelligence, business process, call centre, carbon-based life, Clayton Christensen, clockwork universe, conceptual framework, dark matter, David Brooks, deliberate practice, deskilling, Edward Lloyd's coffeehouse, Elon Musk, Erik Brynjolfsson, estate planning, follow your passion, Frank Levy and Richard Murnane: The New Division of Labor, Freestyle chess, game design, general-purpose programming language, Google Glasses, Hans Lippershey, haute cuisine, income inequality, index fund, industrial robot, information retrieval, intermodal, Internet of things, inventory management, Isaac Newton, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Khan Academy, knowledge worker, labor-force participation, loss aversion, Mark Zuckerberg, Narrative Science, natural language processing, Norbert Wiener, nuclear winter, pattern recognition, performance metric, Peter Thiel, precariat, quantitative trading / quantitative finance, Ray Kurzweil, Richard Feynman, Richard Feynman, risk tolerance, Robert Shiller, Robert Shiller, Rodney Brooks, Second Machine Age, self-driving car, Silicon Valley, six sigma, Skype, speech recognition, spinning jenny, statistical model, Stephen Hawking, Steve Jobs, Steve Wozniak, strong AI, superintelligent machines, supply-chain management, transaction costs, Tyler Cowen: Great Stagnation, Watson beat the top human players on Jeopardy!, Works Progress Administration, Zipcar

It’s the job of a human underwriter in this case to realize that the system might recommend a policy that isn’t priced correctly. • Elicit the information the system needs It’s often not that easy to get the information an automated decision system needs to do its work. In automated financial planning, for example, it’s relatively easy to figure out the ideal stock and bond portfolio for a wealthy individual. But if you’re trying to determine a family’s retirement needs, you have to input current spending levels, risk tolerance, likely retirement dates, and so forth. The client could enter that information him or herself, but it’s often difficult to come up with such data. A human financial planner can help to motivate clients and elicit difficult information. There are many other settings in which humans can play the same type of role. • Persuade humans to take action on automated recommendations Computers can make great decisions, but those decisions often require implementation by humans.


pages: 519 words: 104,396

Priceless: The Myth of Fair Value (And How to Take Advantage of It) by William Poundstone

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availability heuristic, Cass Sunstein, collective bargaining, Daniel Kahneman / Amos Tversky, delayed gratification, Donald Trump, East Village, en.wikipedia.org, endowment effect, equal pay for equal work, experimental economics, experimental subject, feminist movement, game design, German hyperinflation, Henri Poincaré, high net worth, index card, invisible hand, John von Neumann, laissez-faire capitalism, loss aversion, market bubble, mental accounting, meta analysis, meta-analysis, Nash equilibrium, new economy, payday loans, Potemkin village, price anchoring, price discrimination, psychological pricing, Ralph Waldo Emerson, RAND corporation, random walk, RFID, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, rolodex, Steve Jobs, The Chicago School, The Wealth of Nations by Adam Smith, ultimatum game, working poor

Flipping the gains to losses flips the types of behavior. When losses are likely, reckless gambles become acceptable (lower left cell). At the end of the day, racetrack bettors are willing to “throw good money after bad” in the hope they can recoup their losses. When losses are unlikely (lower right), people are willing to insure themselves against them. Financial advisors tell clients to consider their “risk tolerance” in making money decisions. The trouble is, these four domains of behavior coexist in all of us. A person who is risk-averse in one situation will turn reckless in another. All it takes is a changed reference point. Investors regard bonds as “safe” and stocks as a gamble offering a higher average return. Since both investments promise gains, many investors are risk-averse (upper right cell) and load their portfolios with bonds.


pages: 146 words: 43,446

The New New Thing: A Silicon Valley Story by Michael Lewis

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Albert Einstein, Andy Kessler, business climate, Chance favours the prepared mind, data acquisition, family office, high net worth, invention of the steam engine, invisible hand, Jeff Bezos, Menlo Park, pre–internet, risk tolerance, Sand Hill Road, Silicon Valley, Silicon Valley startup, Thorstein Veblen, Y2K

A simple-minded graph with an arrow pointing up and to the right illustrated the principle that the more risk you take with your money, the more you stand to gain or lose. In the past ten months Clark had "lost" $600 million simply by holding Page 164 on to his shares in Netscape. "If they only knew," he said. The Swiss banker chuckled unhappily. Clark remained straight-faced. His eyes drifted farther down the page, to a category marked "Return Objectives and Risk Tolerance." This was a summary of the typical Swiss banker's idea of the range of possible attitudes toward financial risk. It read, Conservative: I seek to... minimize investment volatility. Moderate Growth: I want to take some risk while also preserving capital. High Capital Growth: I have a minimum time horizon of five years with which to pursue my objectives. Next to each risk profile was a little square box.

Frugal Innovation: How to Do Better With Less by Jaideep Prabhu Navi Radjou

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3D printing, additive manufacturing, Affordable Care Act / Obamacare, Airbnb, Albert Einstein, barriers to entry, Baxter: Rethink Robotics, Bretton Woods, business climate, business process, call centre, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, cloud computing, collaborative consumption, collaborative economy, connected car, corporate social responsibility, crowdsourcing, Elon Musk, financial innovation, global supply chain, income inequality, industrial robot, Internet of things, job satisfaction, Khan Academy, Kickstarter, late fees, Lean Startup, low cost carrier, M-Pesa, Mahatma Gandhi, megacity, minimum viable product, more computing power than Apollo, new economy, payday loans, peer-to-peer lending, Peter H. Diamandis: Planetary Resources, precision agriculture, race to the bottom, reshoring, ride hailing / ride sharing, risk tolerance, Ronald Coase, self-driving car, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, six sigma, smart grid, smart meter, software as a service, Steve Jobs, supply-chain management, TaskRabbit, The Fortune at the Bottom of the Pyramid, The Nature of the Firm, transaction costs, unbanked and underbanked, underbanked, women in the workforce, X Prize, yield management, Zipcar

As part of its OpenXC initiative, Ford is fully committed to making vehicle data widely accessible in an open-source format to external developers so they can easily integrate it in their innovative apps. Within one year of its launch, more than 1,000 Ford employees had benefited from the TechShop membership. During this time, these tinkerers have helped Ford boost patentable ideas by over 100% (and the quality of patents has also risen) without having to spend significantly more on R&D. The more entrepreneurial and innovative culture has made Ford more open, agile and risk tolerant. Bill Coughlin, CEO of Ford Global Technologies (Ford’s intellectual property arm), who made it all happen, explains how TechShop has radically shifted the corporate culture:17 There is now greater appreciation for the value of new inventions. Killing a concept that’s only on paper is relatively easy, even a disruptive or breakthrough concept. But the chances of gaining serious consideration are markedly higher when you can quickly prototype it, such as at TechShop, and show it to others.


pages: 402 words: 110,972

Nerds on Wall Street: Math, Machines and Wired Markets by David J. Leinweber

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AI winter, algorithmic trading, asset allocation, banking crisis, barriers to entry, Big bang: deregulation of the City of London, butterfly effect, buttonwood tree, buy low sell high, capital asset pricing model, citizen journalism, collateralized debt obligation, corporate governance, Craig Reynolds: boids flock, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Danny Hillis, demand response, disintermediation, distributed generation, diversification, diversified portfolio, Emanuel Derman, en.wikipedia.org, experimental economics, financial innovation, Gordon Gekko, implied volatility, index arbitrage, index fund, information retrieval, Internet Archive, John Nash: game theory, Khan Academy, load shedding, Long Term Capital Management, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, market fragmentation, market microstructure, Mars Rover, moral hazard, mutually assured destruction, natural language processing, Network effects, optical character recognition, paper trading, passive investing, pez dispenser, phenotype, prediction markets, quantitative hedge fund, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Renaissance Technologies, Richard Stallman, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, semantic web, Sharpe ratio, short selling, Silicon Valley, Small Order Execution System, smart grid, smart meter, social web, South Sea Bubble, statistical arbitrage, statistical model, Steve Jobs, Steven Levy, Tacoma Narrows Bridge, the scientific method, The Wisdom of Crowds, time value of money, too big to fail, transaction costs, Turing machine, Upton Sinclair, value at risk, Vernor Vinge, yield curve, Yogi Berra

For a simple linear cost model, we explicitly construct the efficient frontier in the space of time-dependent liquidation strategies, which have minimum expected cost for a given level of uncertainty. We may then select optimal strategies either by minimizing a quadratic utility function, or minimizing Value at Risk . . . , that explicitly considers the tradeoff between volatility risk and liquidation costs. Figure 3.2 is worth many words in understanding this trading model, and the intuitively appealing implications of its results for traders of different risk tolerances. Trader A is realistically risk-averse, accelerating to reduce risk at the cost of higher impact. Trader B is patient and risk-neutral, executing only to reduce expected costs. Trader C is an unrealistic trader who likes risk and who slows down the execution to get more risk, also incurring more impact cost. The faster trading in path A, to reduce risk, is also what a trader who believed that he had short-term alpha would do to reduce opportunity cost.


pages: 460 words: 122,556

The End of Wall Street by Roger Lowenstein

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Asian financial crisis, asset-backed security, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, Brownian motion, Carmen Reinhart, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, fear of failure, financial deregulation, fixed income, high net worth, Hyman Minsky, interest rate derivative, invisible hand, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, Martin Wolf, moral hazard, mortgage debt, Northern Rock, Ponzi scheme, profit motive, race to the bottom, risk tolerance, Ronald Reagan, savings glut, short selling, sovereign wealth fund, statistical model, the payments system, too big to fail, tulip mania, Y2K

Option ARMs were restyled as “Pick-A-Pay” loans, a name more evocative of lottery tickets than mortgages, and they were marketed to people who were simply unable to pay the full, “non-option” rate. Perhaps Herb Sandler, who had grown up on New York’s Lower East Side, the son of a gambler whose income was devoured by loan sharks, had some empathy with subprime borrowers—or perhaps, as with Killinger, the rising tide of risk tolerance loosened his moorings. The search for growth led Golden West inland to new developments in the California desert, where cookie-cutter homes and no-doc mortgages were the standard. By 2006, they had written more than $100 billion in ARMs,24 and though the Sandlers continued to insist on a margin of collateral, home values were so inflated, and loan applications so rife with fraud, that the quality of their book was as suspect as WaMu’s.


pages: 393 words: 115,263

Planet Ponzi by Mitch Feierstein

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Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Bernie Madoff, centre right, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, disintermediation, diversification, Donald Trump, energy security, eurozone crisis, financial innovation, financial intermediation, Flash crash, floating exchange rates, frictionless, frictionless market, high net worth, High speed trading, illegal immigration, income inequality, interest rate swap, invention of agriculture, Long Term Capital Management, moral hazard, mortgage debt, Northern Rock, obamacare, offshore financial centre, oil shock, pensions crisis, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, purchasing power parity, quantitative easing, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, too big to fail, trickle-down economics, value at risk, yield curve

Governments bailed out the banks. Main Street paid for Wall Street’s excesses. But that doesn’t mean that the scheme is dead and finished with. It just means that the public sector chose to swallow the private sector’s debts. The debts are still there. The bad assets are still there. The same corrupt incentives are still in place. The same degree of profiteering. The same blindness to risk. The same astonishing tolerance for ever-increasing debt. But don’t think all this means that things are as bad as they ever were. They’re not. They’re worse‌—‌much worse. Remember: Ponzi schemes can only operate because of their merry-go-round nature. New dummies providing the influx of funds to pay out the old dummies. But with each cycle, you need more and more dummies‌—‌and sooner or later, you’ll be all out of idiots.

I personally regard them as a lower-risk long-term investment, in the sense that a rising world population and strong growth in the emerging markets will over time force the price of physical commodities (including food) ever higher, especially as currency values erode due to debasement, inflation, and excessive debt (which ultimately will be have to be monetized). If you fancy treading still higher on the risk–reward ladder, there are additional steps which may appeal to a minority of confident investors. If you’re inclined to explore these upper steps, go ahead and do so‌—‌but always bearing in mind that as the opportunity for reward increases, so the risk of loss increases too. You need to evaluate your investments against your own risk tolerance‌—‌very low, low, medium, high, or very high. In general, younger folk can afford to invest a small proportion of their assets in well-researched medium- to high-risk opportunities; but no matter who you are, if you are attracted to high-risk opportunities, make sure you never invest money you can’t afford to lose. I’d say there will be three major themes between now and the end of 2013, or thereabouts.


pages: 478 words: 126,416

Other People's Money: Masters of the Universe or Servants of the People? by John Kay

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Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, call centre, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, cognitive dissonance, corporate governance, Credit Default Swap, cross-subsidies, dematerialisation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, Elon Musk, Eugene Fama: efficient market hypothesis, eurozone crisis, financial innovation, financial intermediation, fixed income, Flash crash, forward guidance, Fractional reserve banking, full employment, George Akerlof, German hyperinflation, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, income inequality, index fund, inflation targeting, interest rate derivative, interest rate swap, invention of the wheel, Irish property bubble, Isaac Newton, London Whale, Long Term Capital Management, loose coupling, low cost carrier, M-Pesa, market design, millennium bug, mittelstand, moral hazard, mortgage debt, new economy, Nick Leeson, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shock, passive investing, peer-to-peer lending, performance metric, Peter Thiel, Piper Alpha, Ponzi scheme, price mechanism, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, random walk, regulatory arbitrage, Renaissance Technologies, rent control, Richard Feynman, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, Schrödinger's Cat, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, sovereign wealth fund, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, Steve Wozniak, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tobin tax, too big to fail, transaction costs, tulip mania, Upton Sinclair, Vanguard fund, Washington Consensus, We are the 99%, Yom Kippur War

Advertisement for Patek Philippe, luxury watch manufacturer Businesses and households use the deposit channel to facilitate their everyday transactions. They also utilise it for short-term savings when they require a high degree of confidence that their money will be available in full when needed. Long-term savers select the investment channel, where they assume a degree of risk in the hope of higher returns. Long time horizons and greater risk-tolerance fit together: the more extended the time-scale, the greater the likelihood that an investment strategy that on average yields a higher return will actually do so. As I described in Chapter 5, the functions of the investment channel involve both search and stewardship. Through the search process described there, capital is allocated through the investment channel to various long-term uses, in business, investment, property and infrastructure.


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The Social Animal: The Hidden Sources of Love, Character, and Achievement by David Brooks

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Albert Einstein, asset allocation, Atul Gawande, Bernie Madoff, business process, Cass Sunstein, choice architecture, clean water, Daniel Kahneman / Amos Tversky, David Brooks, delayed gratification, deliberate practice, disintermediation, Donald Trump, Douglas Hofstadter, Emanuel Derman, en.wikipedia.org, fear of failure, financial deregulation, financial independence, Flynn Effect, George Akerlof, Henri Poincaré, hiring and firing, impulse control, invisible hand, Joseph Schumpeter, labor-force participation, loss aversion, medical residency, meta analysis, meta-analysis, Monroe Doctrine, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, school vouchers, six sigma, Steve Jobs, Steven Pinker, the scientific method, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, Walter Mischel, young professional

He treated clients this way, too. He ignored arguments that didn’t fit his mental framework. He had his group prepare long presentations in which they presumed to lecture people about the industries they’d spent their whole lives mastering. They made presentations deliberately opaque as a way of demonstrating their own expertise. They didn’t understand that different companies have different risk tolerances. They didn’t understand that a particular CFO might be in a power struggle with a particular CEO and they should be careful not to make the latter’s life more difficult. There was no piece of office politics so obvious that they couldn’t be oblivious to it, no attempt at empathic accuracy they could not fail. For Erica, no day was complete unless Harrison and his team had committed some incredible faux pas.


pages: 467 words: 154,960

Trend Following: How Great Traders Make Millions in Up or Down Markets by Michael W. Covel

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Albert Einstein, asset allocation, Atul Gawande, backtesting, Bernie Madoff, Black Swan, buy low sell high, capital asset pricing model, Clayton Christensen, commodity trading advisor, correlation coefficient, Daniel Kahneman / Amos Tversky, delayed gratification, deliberate practice, diversification, diversified portfolio, Elliott wave, Emanuel Derman, Eugene Fama: efficient market hypothesis, fiat currency, fixed income, game design, hindsight bias, housing crisis, index fund, Isaac Newton, John Nash: game theory, linear programming, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market fundamentalism, market microstructure, mental accounting, Nash equilibrium, new economy, Nick Leeson, Ponzi scheme, prediction markets, random walk, Renaissance Technologies, Richard Feynman, Richard Feynman, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, systematic trading, the scientific method, Thomas L Friedman, too big to fail, transaction costs, upwardly mobile, value at risk, Vanguard fund, volatility arbitrage, William of Occam

A diversified portfolio risking 2 percent on each of five instruments has a total heat of 10 percent, as does a portfolio risking 5 percent on each of two instruments.”16 Chauncy DiLaura, a student of Seykota’s, adds to the explanation, “There has to be some governor so I don’t end up with a whole lot of risk. The size of the bet is small around 2 percent.” Seykota calls his risk-adjusted equity “core equity” and the risk tolerance percentage “heat.” Hcan be turned up or down to suit the trader’s pain tolerance—as the heat gets higher, so do the gains, but only up to a point. Past that point, more heat starts to reduce the gain. The trader must be able to select a heat level where he is comfortable.17 Also critical is how you handle your capital as it grows or shrinks. Do you trade the same with $100,000 as you would $200,000?


pages: 629 words: 142,393

The Future of the Internet: And How to Stop It by Jonathan Zittrain

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A Declaration of the Independence of Cyberspace, Amazon Mechanical Turk, Andy Kessler, barriers to entry, book scanning, Brewster Kahle, Burning Man, c2.com, call centre, Cass Sunstein, citizen journalism, Clayton Christensen, clean water, corporate governance, Daniel Kahneman / Amos Tversky, distributed generation, en.wikipedia.org, Firefox, game design, Hacker Ethic, Howard Rheingold, Hush-A-Phone, illegal immigration, index card, informal economy, Internet Archive, jimmy wales, license plate recognition, loose coupling, mail merge, national security letter, packet switching, Post-materialism, post-materialism, pre–internet, price discrimination, profit maximization, Ralph Nader, RFC: Request For Comment, RFID, Richard Stallman, Richard Thaler, risk tolerance, Robert X Cringely, SETI@home, Silicon Valley, Skype, slashdot, software patent, Steve Ballmer, Steve Jobs, Ted Nelson, Telecommunications Act of 1996, The Nature of the Firm, The Wisdom of Crowds, web application, wikimedia commons

This is a variant of Lessig’s idea for a “kid enabled browser,” made much more robust because a tethered appliance is difficult to hack.150 These paternalistic interventions assume that people will be more careful about what they put online once they grow up. And even those who are not more careful and regret it have exercised their autonomy in ways that ought to be respected. But the generational divide on privacy appears to be more than the higher carelessness or risk tolerance of kids. Many of those growing up with the Internet appear not only reconciled to a public dimension to their lives– famous for at least fifteen people—but eager to launch it. Their notions of privacy transcend the Privacy 1.0 plea to keep certain secrets or private facts under control. Instead, by digitally furnishing and nesting within publicly accessible online environments, they seek to make such environments their own.


pages: 443 words: 51,804

Handbook of Modeling High-Frequency Data in Finance by Frederi G. Viens, Maria C. Mariani, Ionut Florescu

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algorithmic trading, asset allocation, automated trading system, backtesting, Black-Scholes formula, Brownian motion, business process, continuous integration, corporate governance, discrete time, distributed generation, fixed income, Flash crash, housing crisis, implied volatility, incomplete markets, linear programming, mandelbrot fractal, market friction, market microstructure, martingale, Menlo Park, p-value, pattern recognition, performance metric, principal–agent problem, random walk, risk tolerance, risk/return, short selling, statistical model, stochastic process, stochastic volatility, transaction costs, value at risk, volatility smile, Wiener process

We numerically estimate the sensitivities of the tranche prices to a change in default correlation in a static model. We explore how dynamic default correlation affects the serial correlation and overall distributions of tranche prices. 4.2 Description of the Products and Models 77 4.2 Description of the Products and Models The function of an MBS vehicle is to allocate capital from investors with a spectrum of risk tolerance to borrowers. Suppose there are investors labeled by interest rates r1 < · · · < rI that they seek, and there are borrowers whose risk levels qualify them for loan rates of r1 < · · · < rB . An MBS portfolio pools together the funds from the investors and issues mortgage loans to the borrowers from this pool (of course, the same considerations apply to other asset-backed loans). More accurately, the interest rates ri label tranches of the portfolio, which the investors may purchase.


pages: 289 words: 113,211

A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber

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affirmative action, Albert Einstein, asset allocation, backtesting, Black Swan, Black-Scholes formula, Bonfire of the Vanities, butterfly effect, commodity trading advisor, computer age, disintermediation, diversification, double entry bookkeeping, Edward Lorenz: Chaos theory, family office, financial innovation, fixed income, frictionless, frictionless market, George Akerlof, implied volatility, index arbitrage, Jeff Bezos, London Interbank Offered Rate, Long Term Capital Management, loose coupling, margin call, market bubble, market design, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, new economy, Nick Leeson, oil shock, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk/return, Robert Shiller, Robert Shiller, rolodex, Saturday Night Live, shareholder value, short selling, Silicon Valley, statistical arbitrage, The Market for Lemons, time value of money, too big to fail, transaction costs, tulip mania, uranium enrichment, yield curve, zero-coupon bond

Even if we assume as a starting point that the stock market is a random walk and 168 ccc_demon_165-206_ch09.qxd 7/13/07 2:44 PM Page 169 T H E B R AV E N E W W O R L D OF HEDGE FUNDS is governed by rational behavior, and even if we assert at the outset that all trades reflect the full consideration of the most up-to-date information, merely the fact that there are winners and losers will lead to booms and busts that have little to do with the rational application of information.1 The simplest market cycle is based on two psychological characteristics of investors. First, their risk tolerance increases as their market winnings pile up. If you are making money, you will be willing to take proportionally more risk in the market.2 This is often termed the house effect, because it is akin to successful gamblers who raise their stakes because they are playing with the casino’s money. Second, the more people win, the smarter they think they are. If investors make money on a market view, they adhere more strongly to that view, even if the real reason behind their success has nothing to do with these beliefs.


pages: 587 words: 117,894

Cybersecurity: What Everyone Needs to Know by P. W. Singer, Allan Friedman

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4chan, A Declaration of the Independence of Cyberspace, Apple's 1984 Super Bowl advert, barriers to entry, Berlin Wall, bitcoin, blood diamonds, borderless world, Brian Krebs, business continuity plan, Chelsea Manning, cloud computing, crowdsourcing, cuban missile crisis, data acquisition, Edward Snowden, energy security, failed state, Fall of the Berlin Wall, fault tolerance, global supply chain, Google Earth, Internet of things, invention of the telegraph, Julian Assange, Khan Academy, M-Pesa, mutually assured destruction, Network effects, packet switching, Peace of Westphalia, pre–internet, profit motive, RAND corporation, ransomware, RFC: Request For Comment, risk tolerance, rolodex, Silicon Valley, Skype, smart grid, Steve Jobs, Stuxnet, uranium enrichment, We are Anonymous. We are Legion, web application, WikiLeaks, zero day

Such technological abstinence sounds extreme, especially when computers have proven so useful in modern war. But imagine if you had a memo that you needed to get to your boss with absolutely no mistakes, at the risk of losing your job. Would you e-mail it if there were a 50 percent risk of it somehow being lost or changed en route? Or would you just hand-deliver it? What about if the risk were 10 percent? How about just 1 percent, but still at the risk of losing your job? Then apply the same risk tolerances when it’s your life in battle rather than your job. How do your risk numbers change? Computer network operations, though, won’t just be limited to targeting command and control with indirect effects. As more and more unmanned systems are introduced into warfare (the US military has over 8,000 “drones” like the famous Predator and Reaper, while over eighty countries now have military robotics programs), targeting command-and-control networks opens up even more direct avenues of attack.


pages: 423 words: 118,002

The Boom: How Fracking Ignited the American Energy Revolution and Changed the World by Russell Gold

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accounting loophole / creative accounting, American energy revolution, Bakken shale, Bernie Sanders, Buckminster Fuller, clean water, corporate governance, energy security, energy transition, hydraulic fracturing, margin call, market fundamentalism, Mason jar, North Sea oil, oil shale / tar sands, oil shock, peak oil, Project Plowshare, risk tolerance, Ronald Reagan, shareholder value, Silicon Valley, Upton Sinclair

Mitchell had a hunch, but the only way to know if he was right was to drill. And that meant he needed to acquire mineral leases to the north of Fort Worth. He didn’t have to wait long. During the day, Mitchell and Houston’s other independent oilmen gathered on the ground floor of the Niels Esperson Building, a peculiar prewar edifice topped with what looks like a stone gazebo. For those with the right combination of money, ambition, risk tolerance, and luck, the Esperson was the first stop on the way to a midcentury career as a wildcatter. There was a bank of pay telephones at the back of the ground floor that functioned as a makeshift office for aspiring oilmen. There was a drugstore that served coffee and sandwiches. Bar stools surrounded several zinc-topped tables. And the Esperson was one of the first buildings in swampy Houston to offer air-conditioning.


pages: 385 words: 128,358

Inside the House of Money: Top Hedge Fund Traders on Profiting in a Global Market by Steven Drobny

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Albert Einstein, asset allocation, Berlin Wall, Bonfire of the Vanities, Bretton Woods, buy low sell high, capital controls, central bank independence, Chance favours the prepared mind, commodity trading advisor, corporate governance, correlation coefficient, Credit Default Swap, diversification, diversified portfolio, family office, fixed income, glass ceiling, high batting average, implied volatility, index fund, inflation targeting, interest rate derivative, inventory management, Long Term Capital Management, margin call, market bubble, Maui Hawaii, Mexican peso crisis / tequila crisis, moral hazard, new economy, Nick Leeson, oil shale / tar sands, oil shock, out of africa, paper trading, Peter Thiel, price anchoring, purchasing power parity, reserve currency, risk tolerance, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, The Wisdom of Crowds, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

When you say no more than 20 percent allocated to one trading strategy, how do you define a strategy? Standing: A strategy would be an RV structure or a macro theme. If two strategies are in the same market, say different parts of the U.S. yield curve, but are not correlated, we would be very comfortable allocating the maximum of risk to each one independently. Gorton: One of the restrictions of our fund being sold as an RV/macro fund is that we have a very low risk tolerance.We tell people that we will never lose more than 5 percent.To date, touch wood, we have never drawn down more than 3.5 percent.That means that even when we see outstanding opportunities, we cannot concentrate risk in that trade and we will underperform a bit.The portfolio effect of running RV and macro strategies has been quite strong but it also tends to skew performance to the middle of the range.

Multicultural Cities: Toronto, New York, and Los Angeles by Mohammed Abdul Qadeer

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affirmative action, call centre, David Brooks, deindustrialization, desegregation, edge city, en.wikipedia.org, Frank Gehry, game design, ghettoisation, global village, immigration reform, Jane Jacobs, knowledge economy, market bubble, McMansion, new economy, New Urbanism, place-making, Richard Florida, risk tolerance, Silicon Valley, Skype, telemarketer, the built environment, The Chicago School, The Death and Life of Great American Cities, the scientific method, urban planning, urban renewal, working-age population, young professional

This approach is called group characteristics.15 Max Weber’s thesis of “the Protestant ethic and the spirit of capitalism” has long ruled over the theories of entrepreneurship.16 Similarly, the fact that Lebanese, Greeks, Syrians, and GujratiIsmailis have dominated local trade in Africa, the Gulf States, and even 94 Multicultural Cities some parts of the Caribbean has given rise to notions of their cultural proclivity for business. They have been given the name “middleman minorities” in contemporary economic sociology. Cultural theory attributes the entrepreneurial propensities of an ethnic group to such values as risk tolerance, family solidarity, frugality, hard work, adventurousness, and faith in one’s destiny as well as community obligations. It is presumed that some cultures cultivate these values and habits more than others. Another theory explaining the entrepreneurial propensity of some ethnic groups is called opportunity structure or the structural approach.17 It suggests that entrepreneurship is a matter of market conditions or opportunity structures.


pages: 537 words: 144,318

The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money by Steven Drobny

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Albert Einstein, Asian financial crisis, asset allocation, asset-backed security, backtesting, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, business process, capital asset pricing model, capital controls, central bank independence, collateralized debt obligation, Commodity Super-Cycle, commodity trading advisor, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, diversification, diversified portfolio, equity premium, family office, fiat currency, fixed income, follow your passion, full employment, Hyman Minsky, implied volatility, index fund, inflation targeting, interest rate swap, inventory management, invisible hand, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, market microstructure, moral hazard, North Sea oil, open economy, peak oil, pension reform, Ponzi scheme, prediction markets, price discovery process, price stability, private sector deleveraging, profit motive, purchasing power parity, quantitative easing, random walk, reserve currency, risk tolerance, risk-adjusted returns, risk/return, savings glut, Sharpe ratio, short selling, sovereign wealth fund, special drawing rights, statistical arbitrage, stochastic volatility, The Great Moderation, time value of money, too big to fail, transaction costs, unbiased observer, value at risk, Vanguard fund, yield curve

You could have had the right view but missed the move, or worse, got run over in the crisis. Views sometimes count very little, whereas good risk management always counts a lot. The top performers in 2008 were able to put on good risk-versus-reward bets at the right time, and had the liquidity to do so due to good risk management. The old style of risk management suggests establishing a “diversified” portfolio with different asset weightings based on risk tolerance and time profile, which does not really work in this environment. If you are 60 years old, you are theoretically supposed to increase your bond weighting. But if you did that at the beginning of 2009—decreased your equities and increased your bonds—you virtually committed suicide. And if the inflation hawks are right, this may prove to be a really bad trade for a long period, even if your timing is reasonably good.


pages: 384 words: 118,572

The Confidence Game: The Psychology of the Con and Why We Fall for It Every Time by Maria Konnikova

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attribution theory, Bernie Madoff, British Empire, Cass Sunstein, cognitive dissonance, Daniel Kahneman / Amos Tversky, endowment effect, epigenetics, hindsight bias, lake wobegon effect, libertarian paternalism, Milgram experiment, placebo effect, Ponzi scheme, publish or perish, Richard Thaler, risk tolerance, side project, Skype, Steven Pinker, the scientific method, tulip mania, Walter Mischel

On another day, in another town, Robin would have laughed; that day, in Manhattan, she fell. It makes a certain kind of sense. Often, patient, levelheaded people will go a bit crazy in the wake of a major life change—we become more impulsive, less stable, riskier versions of ourselves. And our impulsivity and appetite for risk are some of the only reliable indicators of fraud susceptibility. In one study, risk takers were over six times more likely to fall victim than those whose risk tolerance was low. Given the right circumstances, just about anyone can fit that description. When we’re feeling low, we want to get out of the slump. So, schemes or propositions that would look absurd in another light suddenly seem more attractive. When we’re angry, we want to lash out. Suddenly, something that once seemed like a gamble looks awfully appealing. A victim isn’t necessarily foolish or greedy.

Stock Market Wizards: Interviews With America's Top Stock Traders by Jack D. Schwager

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Asian financial crisis, banking crisis, barriers to entry, Black-Scholes formula, commodity trading advisor, computer vision, East Village, financial independence, fixed income, implied volatility, index fund, Jeff Bezos, John von Neumann, locking in a profit, Long Term Capital Management, margin call, paper trading, passive investing, pattern recognition, random walk, risk tolerance, risk-adjusted returns, short selling, Silicon Valley, statistical arbitrage, the scientific method, transaction costs, Y2K

JOHN BENDER It might seem that if you have an edge, the way to maximize the edge is to trade as big as you can. But that's not the case, because of risk. As a professional gambler or as a trader, you are constantly walking the line between maximizing edge and minimizing your risk of tapping out. How do you decide what is the right balance? There is no single right answer to that question. It depends on the individual person's risk tolerance. Let's say you saved up enough money to live out your life in relative comfort but without the ability to make extravagant expenditures. I come along and offer to give you ten-to-one odds on the flip of a coin. The only catch is that you have to bet your entire net worth. That bet has a tremendous edge, but it is probably a bet that you wouldn't want to make, because the value of what you can gain, even though it is a much larger sum of money, is much less than the value of what you could lose.


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Thinking, Fast and Slow by Daniel Kahneman

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Albert Einstein, Atul Gawande, availability heuristic, Black Swan, Cass Sunstein, Checklist Manifesto, choice architecture, cognitive bias, complexity theory, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, delayed gratification, demand response, endowment effect, experimental economics, experimental subject, Exxon Valdez, feminist movement, framing effect, hindsight bias, index card, job satisfaction, John von Neumann, libertarian paternalism, loss aversion, medical residency, mental accounting, meta analysis, meta-analysis, nudge unit, pattern recognition, pre–internet, price anchoring, quantitative trading / quantitative finance, random walk, Richard Thaler, risk tolerance, Ronald Reagan, The Chicago School, The Wisdom of Crowds, transaction costs, union organizing, Walter Mischel, Yom Kippur War

Gerd Gigerenzer, “Personal Reflections on Theory and Psychology,” Theory & Psychology 20 (2010): 733–43. Daniel Kahneman and Amos Tversky, “On the Reality of Cognitive Illusions,” Psychological Review 103 (1996): 582–91. offered plausible alternatives: Some examples from many are Valerie F. Reyna and Farrell J. Lloyd, “Physician Decision-Making and Cardiac Risk: Effects of Knowledge, Risk Perception, Risk Tolerance and Fuzzy-Processing,” Journal of Experimental Psychology: Applied 12 (2006): 179–95. Nicholas Epley and Thomas Gilovich, “The Anchoring-and-Adjustment Heuristic,” Psychological Science 17 (2006): 311–18. Norbert Schwarz et al., “Ease of Retrieval of Information: Another Look at the Availability Heuristic,” Journal of Personality and Social Psychology 61 (1991): 195–202. Elke U. Weber et al., “Asymmetric Discounting in Intertemporal Choice,” Psychological Science 18 (2007): 516–23.

Analysis of Financial Time Series by Ruey S. Tsay

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Asian financial crisis, asset allocation, Black-Scholes formula, Brownian motion, capital asset pricing model, compound rate of return, correlation coefficient, data acquisition, discrete time, frictionless, frictionless market, implied volatility, index arbitrage, Long Term Capital Management, market microstructure, martingale, p-value, pattern recognition, random walk, risk tolerance, short selling, statistical model, stochastic process, stochastic volatility, telemarketer, transaction costs, value at risk, volatility smile, Wiener process, yield curve

Based on the prior introduction, the new approach does not require the choice of a subperiod length n, but it requires the specification of threshold η. Different choices of the threshold η lead to different estimates of the shape parameter k (and hence the tail index −1/k). In the literature, some researchers believe that the choice of η is a statistical problem as well as a financial one, and it cannot be determined purely based on the statistical theory. For example, different financial institutions (or investors) have different risk tolerances. As such, they may select different thresholds even for an identical financial position. For the daily log returns of IBM stock considered in this chapter, the calculated VaR is not sensitive to the choice of η. The choice of threshold η also depends on the observed log returns. For a stable return series, η = −2.5% may fare well for a long position. For a volatile return 285 A NEW APPROACH TO VAR series (e.g., daily returns of a dot-com stock), η may be as low as −10%.


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Debunking Economics - Revised, Expanded and Integrated Edition: The Naked Emperor Dethroned? by Steve Keen

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accounting loophole / creative accounting, banking crisis, banks create money, barriers to entry, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, butterfly effect, capital asset pricing model, cellular automata, central bank independence, citizen journalism, clockwork universe, collective bargaining, complexity theory, correlation coefficient, credit crunch, David Ricardo: comparative advantage, debt deflation, diversification, double entry bookkeeping, en.wikipedia.org, Eugene Fama: efficient market hypothesis, experimental subject, Financial Instability Hypothesis, Fractional reserve banking, full employment, Henri Poincaré, housing crisis, Hyman Minsky, income inequality, invisible hand, iterative process, John von Neumann, laissez-faire capitalism, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market clearing, market microstructure, means of production, minimum wage unemployment, open economy, place-making, Ponzi scheme, profit maximization, quantitative easing, RAND corporation, random walk, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Coase, Schrödinger's Cat, scientific mainstream, seigniorage, six sigma, South Sea Bubble, stochastic process, The Great Moderation, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, total factor productivity, tulip mania, wage slave

(McKibbin and Stoeckel 2009: 584; emphases added) As with Ireland, they manipulate the shocks applied to their model until its short-run deviations from the steady state mimic what occurred during the Great Recession, and as with Ireland, one shock is not enough – three have to be used: 1 the bursting of the housing bubble, causing a reallocation of capital and a loss of household wealth and drop in consumption; 2 a sharp rise in the equity risk premium (the risk premium of equities over bonds), causing the cost of capital to rise, private investment to fall, and demand for durable goods to collapse; 3 a reappraisal of risk by households, causing them to discount their future labor income and increase savings and decrease consumption. (Ibid.: 587) Not even this was enough to replicate the data: they also needed to assume that two of these ‘shocks’ – the risk tolerances of business and households – changed their magnitudes over the course of the crisis. A previous paper had found that ‘a temporary shock to risk premia, as seems to have happened in hindsight, does not generate the large observed real effects,’ so they instead considered an extreme shock, followed by an attenuation of it later: ‘The question is then, what would happen if business and households initially assumed the worst – that is, a long lasting permanent rise in risk premia – but unexpectedly revised their views on risk to that of a temporary scenario 1 year later whereby things are expected to return to “normal”?’


pages: 701 words: 199,010

The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal by Ludwig B. Chincarini

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affirmative action, asset-backed security, automated trading system, bank run, banking crisis, Basel III, Bernie Madoff, Black-Scholes formula, buttonwood tree, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discounted cash flows, diversification, diversified portfolio, family office, financial innovation, financial intermediation, fixed income, Flash crash, full employment, Gini coefficient, high net worth, hindsight bias, housing crisis, implied volatility, income inequality, interest rate derivative, interest rate swap, labour mobility, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low skilled workers, margin call, market design, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, Northern Rock, Occupy movement, oil shock, price stability, quantitative easing, quantitative hedge fund, quantitative trading / quantitative finance, Ralph Waldo Emerson, regulatory arbitrage, Renaissance Technologies, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Sharpe ratio, short selling, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, systematic trading, The Great Moderation, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

Alex Kirk, who was head of Lehman’s credit business, and Gelband were concerned about Lehman’s overall exposure. In April 2007, Kirk e-mailed Gelband: As a heads up our risk of mandated commits is up to 6mm a bp triple our previous high. Also the commits are coming in fast and furious I expect us to be well north of 30B this quarter. This is also unprecedented. In addition we are now seeing commitments that have crossed the risk tolerance so we may need your help with the bank in saying no to some key clients. —Alex Kirk, Head of Credit Business, e-mail to Michael Gelband, April 20, 2007 (Valukas 2010) Soon after that, Lehman fired Gelband.21 Lawrence McCarthy, another important part of fixed-income trading, left shortly thereafter. In his exit interview with human resources, he told them how out of touch Dick Fuld was with the company.


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Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram Rajan

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accounting loophole / creative accounting, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, barriers to entry, Bernie Madoff, Bretton Woods, business climate, Clayton Christensen, clean water, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, diversification, Edward Glaeser, financial innovation, floating exchange rates, full employment, global supply chain, Goldman Sachs: Vampire Squid, illegal immigration, implied volatility, income inequality, index fund, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, knowledge worker, labor-force participation, Long Term Capital Management, market bubble, Martin Wolf, medical malpractice, microcredit, moral hazard, new economy, Northern Rock, offshore financial centre, open economy, price stability, profit motive, Real Time Gross Settlement, Richard Florida, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, school vouchers, short selling, sovereign wealth fund, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, Vanguard fund, women in the workforce, World Values Survey

Instead, the risk premium on long-term government bonds—the additional spread that the market demands to take the risk of bond prices fluctuating—fell even as the Fed raised short-term interest rates, with the result that long-term interest rates fell and bond prices rose.7 Indeed, a generally low premium for risk ensured that the prices of all risky or long-term assets, including housing, rose, even as the Fed raised rates slowly. The Fed’s policy seemed to be working because it made risk more tolerable! The Fed did worry about the deteriorating quality of lending and made some supervisory noises over time. But with its foot pressed firmly on the interest-rate accelerator, the supervisory measures were ineffective. Ultimately, it was probably also Fed actions that brought the party to an end. Higher short-term interest rates raised the payments on adjustable-rate mortgages as well as prospective payments on mortgages with rate resets.


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Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe by Gillian Tett

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accounting loophole / creative accounting, asset-backed security, bank run, banking crisis, Black-Scholes formula, Bretton Woods, business climate, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, easy for humans, difficult for computers, financial innovation, fixed income, housing crisis, interest rate derivative, interest rate swap, locking in a profit, Long Term Capital Management, McMansion, mortgage debt, North Sea oil, Northern Rock, Renaissance Technologies, risk tolerance, Robert Shiller, Robert Shiller, short selling, sovereign wealth fund, statistical model, The Great Moderation, too big to fail, value at risk, yield curve

The ruling attracted almost no attention in the press at the time, since it seemed highly technical, but it had one very considerable consequence: it raised the competitive pressure on the brokerages even further. By 2005, it had become clear that a key reason why Goldman Sachs was producing such stellar earnings was that it had raised its leverage. Merrill Lynch and the others were therefore under intense pressure to follow suit, and, that being the case, the increased leverage of super-senior risk was tolerated. The three other major brokerages—Bear Stearns, Morgan Stanley, and Lehman Brothers—also built up some super-senior exposure. Bear and Lehman had extensive experience in dealing with mortgage-backed bonds, and they prided themselves on running tight risk controls. As they each cranked up their CDO machines, they realized that super-senior risk was becoming like the toxic by-product of a chemical experiment or waste from a nuclear reactor.


pages: 309 words: 95,495

Culture of Terrorism by Noam Chomsky

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anti-communist, Bolshevik threat, Bretton Woods, centre right, clean water, David Brooks, failed state, land reform, Monroe Doctrine, risk tolerance, Ronald Reagan, union organizing

But “things could be worse,” he concludes, employing a phrase that expresses the commitments of the media that are sometimes better concealed behind a mask of “objectivity”; fortunately, “left-wing movements in Central America have lost strength over the past few years, and revolution doesn’t seem to be brewing in the region”—thanks to the successful use of terror to destroy “popular organizations,” as he fails to observe. Still, there is the danger that “the Sandinistas will infiltrate [neighboring] countries with Marxist-trained student, union and peasant leaders promoting Nicaragua’s ‘revolution without frontiers’.”6 The New York Times editors, contemplating the likely failure of the U.S. military option, propose that Washington take a “calculated risk” and “tolerate a Marxist neighbor, if it is boxed in by treaties and commitments to rudimentary human rights.” The Sandinistas would have to agree “to keep Soviet and Cuban bases, advisers and missiles out of Nicaragua,” and to observe human rights, a major issue standing alongside of U.S. security concerns, because Washington and its Central American allies “rightly see a connection between internal and external behavior.”7 One hardly knows which of these two ideas is more bizarre: the demand that Nicaragua adhere to treaty limitations barring foreign bases and advisers and missiles (the missiles added gratuitously by the Times editors to induce the proper hysteria)—agreements that Nicaragua has consistently supported along with controls to prevent cross-border operations, in vain, since the U.S. will accept no such constraints; or the concern over human rights violations in Nicaragua, real enough to be sure, but slight in comparison with those conducted by Times favorites, whose atrocities apparently raise no problem about a “connection between internal and external behavior,” and are of little significance in any event, being directed against the poor majority who are the natural enemy of the Free Press.


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The Payoff by Jeff Connaughton

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algorithmic trading, bank run, banking crisis, Bernie Madoff, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cuban missile crisis, desegregation, Flash crash, locking in a profit, London Interbank Offered Rate, London Whale, Long Term Capital Management, naked short selling, Plutocrats, plutocrats, Ponzi scheme, risk tolerance, short selling, Silicon Valley, too big to fail, two-sided market, young professional

And what did WaMu management do when it became clear that fraud rates were rising as housing prices began to fall? Rather than curb its reckless practices, it decided to try to sell a higher proportion of these risky, fraud-tainted mortgages into the secondary market, thereby locking in a profit for itself as it spread the contagion into the capital markets. The second hearing showed that OTS had failed abjectly to regulate WaMu and to protect the public from the consequences of WaMu’s excessive risk-taking and toleration of widespread fraud. Although WaMu accounted for 25 percent of OTS’s regulatory portfolio, OTS adopted a laissez-faire approach. OTS’s front-line bank examiners had identified the high prevalence of fraud and weak internal controls at WaMu, yet the OTS leadership did virtually nothing to address the situation. In fact, OTS advocated for WaMu with other regulators and, in 2007 and 2008, had actively thwarted an investigation of WaMu by the Federal Deposit Insurance Corporation (FDIC).


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Money and Power: How Goldman Sachs Came to Rule the World by William D. Cohan

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asset-backed security, Bernie Madoff, buttonwood tree, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, fear of failure, financial innovation, fixed income, Ford paid five dollars a day, Goldman Sachs: Vampire Squid, Gordon Gekko, high net worth, hiring and firing, hive mind, Hyman Minsky, interest rate swap, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, merger arbitrage, moral hazard, mortgage debt, paper trading, passive investing, Ponzi scheme, price stability, profit maximization, risk tolerance, Ronald Reagan, Saturday Night Live, South Sea Bubble, time value of money, too big to fail, traveling salesman, value at risk, yield curve, Yogi Berra

But was this relentless focus on profit a recipe for dispensing with the system of “checks and balances” that was in place to prevent conflicts between client needs and Goldman’s own trading accounts? This question would come back to haunt Goldman with a vengeance in 2010. To Corzine, the lessons of 1994 were clear. “Permanency of capital was essential,” he said. “You could not have everybody’s life at risk because people have different risk tolerances and can take their capital out at a moment’s notice. I didn’t have religious fervor [about an IPO] in 1986, but I was supportive. I had religious fervor after 1994 because you can’t have a two-hundred-and-fifty-billion-dollar balance sheet stretched around the world, operating twenty-four hours a day built on capital that could walk out the door and have no real transparency whatsoever about what you’re doing.”


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Culture and Prosperity: The Truth About Markets - Why Some Nations Are Rich but Most Remain Poor by John Kay

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Albert Einstein, Asian financial crisis, Barry Marshall: ulcers, Berlin Wall, Big bang: deregulation of the City of London, California gold rush, complexity theory, computer age, constrained optimization, corporate governance, corporate social responsibility, correlation does not imply causation, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, Donald Trump, double entry bookkeeping, double helix, Edward Lloyd's coffeehouse, equity premium, Ernest Rutherford, European colonialism, experimental economics, Exxon Valdez, failed state, financial innovation, Francis Fukuyama: the end of history, George Akerlof, George Gilder, greed is good, haute couture, illegal immigration, income inequality, invention of the telephone, invention of the wheel, invisible hand, John Nash: game theory, John von Neumann, Kevin Kelly, knowledge economy, labour market flexibility, late capitalism, Long Term Capital Management, loss aversion, Mahatma Gandhi, market bubble, market clearing, market fundamentalism, means of production, Menlo Park, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, moral hazard, Naomi Klein, Nash equilibrium, new economy, oil shale / tar sands, oil shock, pets.com, popular electronics, price discrimination, price mechanism, prisoner's dilemma, profit maximization, purchasing power parity, QWERTY keyboard, Ralph Nader, RAND corporation, random walk, rent-seeking, risk tolerance, road to serfdom, Ronald Coase, Ronald Reagan, second-price auction, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, Steve Jobs, telemarketer, The Chicago School, The Death and Life of Great American Cities, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, total factor productivity, transaction costs, tulip mania, urban decay, Washington Consensus, women in the workforce, yield curve, yield management


pages: 482 words: 147,281

A Crack in the Edge of the World: America and the Great California Earthquake of 1906 by Simon Winchester

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Albert Einstein, butterfly effect, California gold rush, Golden Gate Park, index card, indoor plumbing, Loma Prieta earthquake, Menlo Park, place-making, risk tolerance, Silicon Valley, South of Market, San Francisco, supervolcano, The Chicago School, transcontinental railway, wage slave, Works Progress Administration

The National Board of Fire Underwriters had remarked only the year before, after an extensive survey, that the city remained a tinderbox, waiting to be consumed once again as it had been six times already in the half century of its existence. Chief Sullivan concurred, often vehemently. Such was the flammability of its structures, the lack of water, the vulnerability of the supply and the eccentric siting of some of the fire stations that insurers found the risks barely tolerable. There were only thirty-eight steam-powered fire engines in service, and tests had shown they could deliver water at only 70 per cent of their rated capacity – much too low for comfort. The men who manned the engines were poorly trained. There were too few hydrants, and the old cisterns that long before had been built to store water below intersections in the city-centre were rusty and empty and unused.


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Drugs Without the Hot Air by David Nutt

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British Empire, double helix, en.wikipedia.org, knowledge economy, meta analysis, meta-analysis, offshore financial centre, randomized controlled trial, risk tolerance, Robert Gordon, War on Poverty

Perhaps in the future we’ll understand anxiety disorders in a more sophisticated way, and be able to treat them much more effectively. In general, although physical dependence on benzodiazepines is common and withdrawal can sometimes be problematic, the psychological cravings that characterise addiction are extremely rare when benzodiazepines are taken as directed by the doctor. Whether it’s worth risking building up tolerance and possibly suffering withdrawal symptoms, depends on individual factors – especially how ill you are and how much the benzodiazepines help you. The decision requires the same sort of weighing up of the harms and benefits as with any drug. Antidepressants and SSRIs Selective serotonin reuptake inhibitors (SSRIs) were first developed in the 1970s. They have become the most-commonly prescribed type of antidepressants worldwide in the last two decades.


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Why geography matters: three challenges facing America : climate change, the rise of China, and global terrorism by Harm J. De Blij

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agricultural Revolution, airport security, Anton Chekhov, Ayatollah Khomeini, Berlin Wall, British Empire, colonial exploitation, complexity theory, computer age, crony capitalism, demographic transition, Deng Xiaoping, Eratosthenes, European colonialism, F. W. de Klerk, failed state, Fall of the Berlin Wall, Francis Fukuyama: the end of history, global village, illegal immigration, Internet Archive, John Snow's cholera map, Khyber Pass, manufacturing employment, megacity, Mercator projection, out of africa, RAND corporation, risk tolerance, Ronald Reagan, South China Sea, special economic zone, Thomas Malthus, trade route, transatlantic slave trade, UNCLOS, UNCLOS

China's installation of batteries of missiles aimed at Taiwan is troubling, since the Chinese are well aware of United States commitments to protect the Taiwanese. Time will soften the rough edges of this problem, and already has: two decades ago it was incon- ceivable that Taiwanese investment in China's Pacific Rim economy would even be possible, let alone reach the dimensions it has. An outbreak of armed conflict would be catastrophic for all three parties. Nothing that increases this risk should be tolerated, and Washington must convince Beijing that this must be a joint objective. Over the longer term, China's economic and geopolitical challenge will be more difficult to accommodate, and the American role in East Asia will undoubtedly have to change. China has unresolved issues with Japan ranging from Japan's failure to acknowledge the atrocities it committed in China during its wartime occupation to disputes over islands and waters in the South China Sea.


pages: 382 words: 120,064

Bank 3.0: Why Banking Is No Longer Somewhere You Go but Something You Do by Brett King

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3D printing, additive manufacturing, Albert Einstein, Amazon Web Services, Any sufficiently advanced technology is indistinguishable from magic, asset-backed security, augmented reality, barriers to entry, bitcoin, bounce rate, business intelligence, business process, business process outsourcing, call centre, capital controls, citizen journalism, Clayton Christensen, cloud computing, credit crunch, crowdsourcing, disintermediation, en.wikipedia.org, George Gilder, Google Glasses, high net worth, I think there is a world market for maybe five computers, Infrastructure as a Service, invention of the printing press, Jeff Bezos, jimmy wales, London Interbank Offered Rate, M-Pesa, Mark Zuckerberg, mass affluent, microcredit, mobile money, more computing power than Apollo, Northern Rock, Occupy movement, optical character recognition, performance metric, platform as a service, QWERTY keyboard, Ray Kurzweil, recommendation engine, RFID, risk tolerance, self-driving car, Skype, speech recognition, stem cell, telepresence, Tim Cook: Apple, transaction costs, underbanked, web application

The key problem is this: We need to measure accurately the total journey or engagement of the customer end to end, not just the last step in the journey. As a customer I may very well use the Internet to research my investment options, so before I go to the advisor in the branch, or he comes to see me at my office, I may very well have decided the asset classes I want to invest in, the investment horizon, the level of risk I am prepared to take. I may have gone online and used a risk profile questionnaire to see what level of risk I will tolerate. I may have used websites or magazines on investments to look at whether it is the right time to invest in my local property market, or in blue-chip banking stocks. I may be part of an investment club online; I may even have my own online brokerage account separate from my retail bank. So while I may engage with an advisor in the final stage to execute a transaction, I may have already made the all of the critical decisions long before my meeting with the human advisor.

Trade Your Way to Financial Freedom by van K. Tharp

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asset allocation, commodity trading advisor, compound rate of return, computer age, Elliott wave, high net worth, margin call, market fundamentalism, pattern recognition, prediction markets, random walk, risk tolerance, short selling, statistical model, transaction costs

How can you prepare for that so that it will not occur? Our clients are definitely lookingfor divers$ication. We provide that withfour difirent programs that strivefor returns in the 10-20 percent range with lower drawdowns. We’re lookingfor returns of 20 percent with 10 percent drawdowns. Our clients know that, so that’s what they’re getting in terms of their goals. Since you are trading clients’ money, how much risk can they tolerate? When would they be likely to withdraw their money? They expect risk in the 5-10 percent range. Any drawdown that is over 15 percent or fhat lasts~over a year is deadly-lots of clients would fire us. 55 The worst thing that can happen to a client is a surprise. We make sure that doesn’t happen by educating our clients. 1 even wrote a book to prepare them, Panic Proof Investing.2 How will you handle a large infusion of new capital or a large withdrawal?


pages: 589 words: 147,053

The Age of Em: Work, Love and Life When Robots Rule the Earth by Robin Hanson

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8-hour work day, artificial general intelligence, augmented reality, Berlin Wall, bitcoin, blockchain, brain emulation, business process, Clayton Christensen, cloud computing, correlation does not imply causation, demographic transition, Erik Brynjolfsson, ethereum blockchain, experimental subject, fault tolerance, financial intermediation, Flynn Effect, hindsight bias, job automation, job satisfaction, Just-in-time delivery, lone genius, Machinery of Freedom by David Friedman, market design, meta analysis, meta-analysis, Nash equilibrium, new economy, prediction markets, rent control, rent-seeking, reversible computing, risk tolerance, Silicon Valley, smart contracts, statistical model, stem cell, Thomas Malthus, trade route, Turing test, Vernor Vinge

For example, we should expect more industriousness relative to indulgence, a work relative to a leisure orientation, time orientations that are long term relative to short term and that are tied to clocks instead of relationships, low instead of high context attitudes toward rules and communication, and a loose relative to tight attitude on interpreting social norms. For other standard cultural dimensions, productivity considerations don’t as clearly suggest which direction an em world favors. These dimensions include degree of avoidance of risk and uncertainty, tolerance of inequality, individual or group identity, cooperative or competitive emphasis, and high or low emotional expressiveness. Today, about 70% of the variation in values across nations is captured in just two key factors (Inglehart and Welzel 2010). These two factors also capture much of the variation in individual values (Schwartz et al. 2012). One factor varies primarily between rich and poor nations: increasing wealth seems to cause more individualism, universalism, egalitarianism, autonomy, and self-expression.


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The Price of Everything: And the Hidden Logic of Value by Eduardo Porter

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Asian financial crisis, Ayatollah Khomeini, banking crisis, barriers to entry, Berlin Wall, British Empire, capital controls, Carmen Reinhart, Cass Sunstein, clean water, Credit Default Swap, Deng Xiaoping, Edward Glaeser, European colonialism, Fall of the Berlin Wall, financial deregulation, Ford paid five dollars a day, full employment, George Akerlof, Gordon Gekko, guest worker program, happiness index / gross national happiness, housing crisis, illegal immigration, immigration reform, income inequality, income per capita, informal economy, invisible hand, Jean Tirole, John Maynard Keynes: technological unemployment, Kenneth Rogoff, labor-force participation, laissez-faire capitalism, loss aversion, low skilled workers, Martin Wolf, means of production, Menlo Park, Mexican peso crisis / tequila crisis, new economy, New Urbanism, pension reform, Peter Singer: altruism, pets.com, placebo effect, price discrimination, price stability, rent-seeking, Richard Thaler, rising living standards, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, Silicon Valley, stem cell, Steve Jobs, Stewart Brand, superstar cities, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, trade route, transatlantic slave trade, transatlantic slave trade, ultimatum game, unpaid internship, urban planning, women in the workforce, World Values Survey, Yom Kippur War, young professional


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Bold: How to Go Big, Create Wealth and Impact the World by Peter H. Diamandis, Steven Kotler

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3D printing, additive manufacturing, Airbnb, Amazon Mechanical Turk, Amazon Web Services, augmented reality, autonomous vehicles, cloud computing, crowdsourcing, Daniel Kahneman / Amos Tversky, dematerialisation, deskilling, Elon Musk, en.wikipedia.org, Exxon Valdez, fear of failure, Firefox, Galaxy Zoo, Google Glasses, Google Hangouts, Google X / Alphabet X, gravity well, industrial robot, Internet of things, Jeff Bezos, John Harrison: Longitude, Jono Bacon, Just-in-time delivery, Kickstarter, Kodak vs Instagram, Law of Accelerating Returns, Lean Startup, life extension, loss aversion, Louis Pasteur, Mahatma Gandhi, Mark Zuckerberg, Mars Rover, meta analysis, meta-analysis, microbiome, minimum viable product, move fast and break things, Narrative Science, Netflix Prize, Network effects, Oculus Rift, optical character recognition, packet switching, PageRank, pattern recognition, performance metric, Peter H. Diamandis: Planetary Resources, Peter Thiel, pre–internet, Ray Kurzweil, recommendation engine, Richard Feynman, Richard Feynman, ride hailing / ride sharing, risk tolerance, rolodex, self-driving car, sentiment analysis, shareholder value, Silicon Valley, Silicon Valley startup, skunkworks, Skype, smart grid, stem cell, Stephen Hawking, Steve Jobs, Steven Levy, Stewart Brand, technoutopianism, telepresence, telepresence robot, Turing test, urban renewal, web application, X Prize, Y Combinator


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Wall Street: How It Works And for Whom by Doug Henwood

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accounting loophole / creative accounting, affirmative action, Andrei Shleifer, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, borderless world, Bretton Woods, British Empire, capital asset pricing model, capital controls, central bank independence, corporate governance, correlation coefficient, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, dematerialisation, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, experimental subject, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, George Gilder, hiring and firing, Hyman Minsky, implied volatility, index arbitrage, index fund, interest rate swap, Internet Archive, invisible hand, Isaac Newton, joint-stock company, Joseph Schumpeter, kremlinology, labor-force participation, late capitalism, law of one price, liquidationism / Banker’s doctrine / the Treasury view, London Interbank Offered Rate, Louis Bachelier, market bubble, Mexican peso crisis / tequila crisis, microcredit, minimum wage unemployment, moral hazard, mortgage debt, mortgage tax deduction, oil shock, payday loans, pension reform, Plutocrats, plutocrats, price mechanism, price stability, prisoner's dilemma, profit maximization, Ralph Nader, random walk, reserve currency, Richard Thaler, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, shareholder value, short selling, Slavoj Žižek, South Sea Bubble, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, transcontinental railway, women in the workforce, yield curve, zero-coupon bond


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Inviting Disaster by James R. Chiles

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airline deregulation, cuban missile crisis, Exxon Valdez, Maui Hawaii, Milgram experiment, North Sea oil, Piper Alpha, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance

Escape routes are part of preserving a little safety margin for the really bad day. Is that kind of advance planning proof that high-reliability organizations have really arrived? Or would it make any difference for the complex and interactive system that Charles Perrow worries about? For myself, I make no arguments that anything can be made perfectly safe, nor do I know what “safe enough” means. In a national emergency the American public eagerly puts up with risks they’d never tolerate otherwise. Put me down as one who thinks we’ll have to settle for systems that have problems on a regular basis. If the systems are resilient and the workers have support from the top, problems will likely stop well short of disaster—most of the time. But where the consequences are irreversible and final, such as an accidental nuclear war, like Scott Sagan I find it hard to believe that we’ll be able to keep our collective finger on this hair trigger indefinitely without twitching even once.


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How Markets Fail: The Logic of Economic Calamities by John Cassidy

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Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Bretton Woods, British Empire, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, laissez-faire capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, Mont Pelerin Society, moral hazard, mortgage debt, Naomi Klein, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund


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The mote in God's eye by Larry Niven; Jerry Pournelle

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British Empire, clean water, gravity well, risk tolerance, the market place

This is the class they choose to command their ships of war!" "Turn around." "You are a Master but you are not my Master." "Obey," said Ivan. Ivan was not good at argument. Charlie was. As Jock twitched and stammered in internal conflict, Charlie switched to an ancient, half-forgotten language, less for concealment than to remind Jock how much they had to conceal. "If we had many Mediators the risk would be tolerable; but if you should go mad now, policy would be decided by Ivan and me alone, Your Master would not be represented." "But the dangers that threaten our world-" "Consider the record of your sisters. Sally Fowler's Mediator now goes about telling Masters that the world could be made perfect if they would exercise restraint in their breeding. Horace Bury's Mediator-" "If we could learn-" "-cannot be found.


pages: 746 words: 221,583

The Children of the Sky by Vernor Vinge

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combinatorial explosion, epigenetics, indoor plumbing, megacity, random walk, risk tolerance, technological singularity, the scientific method, Vernor Vinge

“You’re right about the manuals, Øvin. Down Here, they can’t do repairs. On the other hand, Oobii does have an enormous amount of information about coldsleep implementations. If you could devise a search list that uses what you see in the casket manuals and properly feed that to Oobii.…” “You’d really help? Even after…?” Ravna nodded. “One important decision you have to make is what level of medical risk you will tolerate.” Her gaze drifted almost involuntarily to where Timor sat on the other side of the room. “Oh.” Then Øvin seemed to follow her gaze. “Oh!… I remember risk was one of the reasons you wanted to postpone this kind of work.” He watched Timor Ristling for a few moments. Timor had set his workstation display to large, perhaps so it would be easier for Belle to follow what he was doing. That was wasted effort, since the foursome had curled up on the floor around his chair, all eyes closed.


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In the Plex: How Google Thinks, Works, and Shapes Our Lives by Steven Levy

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23andMe, AltaVista, Anne Wojcicki, Apple's 1984 Super Bowl advert, autonomous vehicles, book scanning, Brewster Kahle, Burning Man, business process, clean water, cloud computing, crowdsourcing, Dean Kamen, discounted cash flows, don't be evil, Douglas Engelbart, El Camino Real, fault tolerance, Firefox, Gerard Salton, Google bus, Google Chrome, Google Earth, Googley, HyperCard, hypertext link, IBM and the Holocaust, informal economy, information retrieval, Internet Archive, Jeff Bezos, Kevin Kelly, Mark Zuckerberg, Menlo Park, optical character recognition, PageRank, Paul Buchheit, Potemkin village, prediction markets, recommendation engine, risk tolerance, Sand Hill Road, Saturday Night Live, search inside the book, second-price auction, Silicon Valley, skunkworks, Skype, slashdot, social graph, social software, social web, spectrum auction, speech recognition, statistical model, Steve Ballmer, Steve Jobs, Steven Levy, Ted Nelson, telemarketer, trade route, traveling salesman, Vannevar Bush, web application, WikiLeaks, Y Combinator

While the Street View team was creating a system to log the active Wi-Fi networks in the areas it mapped (to increase the accuracy of its data), it made use of that rogue code, presumably unaware that it would enable the Street View vehicles to perform surveillance activities. The mystery was why no one at Google noticed that Street View servers were loaded with gigabytes of data that had no business being there. In any case, collecting the information was a potential violation of data security laws, and the transgression triggered investigations in several countries and states. The incident exposed the risks that arise when tolerance of a company’s information retention policies is at the limit. Even its tiniest mistakes called attention to the larger truth—that Google had a frightening amount of information under its control. And when something major went wrong, like the Street View Wi-Fi debacle, it eroded Google’s main line of defense when justifying its stewardship of the world’s information: trust. Google’s next antitrust crisis after DoubleClick began in February 2008, as a consequence of a hostile bid made by Microsoft to take over Yahoo.


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The Making of Global Capitalism by Leo Panitch, Sam Gindin

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accounting loophole / creative accounting, airline deregulation, anti-communist, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Basel III, Big bang: deregulation of the City of London, bilateral investment treaty, Branko Milanovic, Bretton Woods, BRICs, British Empire, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collective bargaining, continuous integration, corporate governance, Credit Default Swap, crony capitalism, currency manipulation / currency intervention, currency peg, dark matter, Deng Xiaoping, disintermediation, ending welfare as we know it, eurozone crisis, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, full employment, Gini coefficient, global value chain, guest worker program, Hyman Minsky, imperial preference, income inequality, inflation targeting, interchangeable parts, interest rate swap, Kenneth Rogoff, land reform, late capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, manufacturing employment, market bubble, market fundamentalism, Martin Wolf, means of production, money: store of value / unit of account / medium of exchange, Monroe Doctrine, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, Northern Rock, oil shock, precariat, price stability, quantitative easing, Ralph Nader, RAND corporation, regulatory arbitrage, reserve currency, risk tolerance, Ronald Reagan, seigniorage, shareholder value, short selling, Silicon Valley, sovereign wealth fund, special drawing rights, special economic zone, structural adjustment programs, The Chicago School, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transcontinental railway, trickle-down economics, union organizing, very high income, Washington Consensus, Works Progress Administration, zero-coupon bond

By the 1980s and 1990s the greater mobility of financial capital across sectors, space, and time (especially via derivatives)—that is, financial capital’s quality as general or “abstract” capital—greatly intensified domestic and international competition at the same time as it brought a much greater degree of financial volatility. Thus, while the phenomenal growth of financial markets since the 1980s led to over-leveraging and excessive risk-taking, this was tolerated and in fact encouraged for reasons that went far beyond the competitive dynamics and power of finance itself. It was accepted because financial markets had become so crucial to the domestic and global expansion of capitalism in general. Despite the sheer tenacity of the view, going back to the theories of imperialism a century earlier, that overaccumulation is the source of all capitalist crises, the crisis that erupted in the US in 2007 was not caused by a profit squeeze or collapse of investment due to general overaccumulation in the economy.54 In the US, in particular, profits and investments had recovered strongly since the early 1980s.


pages: 900 words: 241,741