10.06
Financial markets are increasing every day in an amazing degree of sophistication and operational efficiency. One of its main functions in addition to financial intermediation is the transfer of risk, a role among others, by means of derivatives. All this contributes to management and appropriate transfer of risk among economic agents. However, without adequate definition of the risk, the use of these tools may prove even more dangerous.
Are common in financial literature that the risk is the probability of suffering a loss. The problem is that the notion of objective probabilities in the real world does not exist, it is impossible to determine the set of possible events.
When we are in a dice game, we can use the techniques of objective probabilities, then the set of possibilities is well defined and is the six numbers. But in real life, no one imagined, within the range of possibilities, the terrorist attack of September 11 in the United States. If we rely on the objectivity of the statistics, then we are simply liquidated as dealers.
The ill effects of a definition of risk based solely on objective math, it adds to the extent that we ignore or do not care to establish the cause and effect relationships between categories such as volatility, surprise, uncertainty and risk, among others. The questions we want answered in a clear and distinct are: what is produced or what causes the risk? and how the above categories are related to the risk?
We start our investigation by analyzing the causes when we suffer a loss on an investment. When that happens we argue that market conditions were difficult. And in this case we generally refer to the presence of volatile.
But what causes volatility? If you look carefully, it is common to a certain level of volatility, which always exists as shown by the VIX index, could suddenly add more volatility to the occurrence of a surprise, either positive or negative. Thus we see that what causes increased volatility are the surprises and volatility in itself for the possibility of occurrence of surprises. In turn, the surprise factor is present, provided that we are in a situation of uncertainty. Perfectly controlled environments, there is no uncertainty and therefore no surprises occur.
Uncertainty is the condition where we can not know in advance that might happen. Mathematically speaking, we are unable to clearly define the set of all possibilities. We can now define the danger and the conditions under which it is certain that we will suffer damage.
As before, we see clearly that the risk is caused by uncertainty. In controlled environments, there is no uncertainty, no surprise, therefore no risk.
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