Expectations, outcomes and risk

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Abstract:

In the investment management business, relative tracking error has been widely adopted as the standard measure of risk. Following a recent bubble and a bear market in equities, investors are looking to develop a richer understanding. This paper argues for a different interpretation of risk that links it directly to expectations and outcomes and proposes to measure risk in those terms. The properties of this risk measure are established. The direct inclusion of expectations makes risk investor specific and reveals the importance of time horizon. Expectations are as important here as outcomes, and unrealistic expectations increase risk. Making risk specific to the investor and adopting an appropriate and reasonable set of investment assumptions is a new starting point for practical risk management.Journal of Asset Management (2004) 5, 223–229; doi:10.1057/palgrave.jam.2240141

Document Type: Research Article

DOI: http://dx.doi.org/10.1057/palgrave.jam.2240141

Publication date: December 1, 2004

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