Category Archives: Risk

Market Volatility Revisited (Coronavirus Edition)…

Not that anyone is counting, but market volatility today is comparable numerically to market volatility in the depths of the global financial crisis of 2007-2009. Today, the CBOE’s implied volatility index (ticker symbol VIX) closed at 54.46. Putting this into a historical perspective, this level is at the 99.43rd percentile for all 7,557 daily observations on VIX recorded daily during the 30-year period spanning 1/2/1990 – 12/27/2019. The last time that VIX closed at this high of a level occurred on November 5, 2008, when it closed at 54.56.

For more information about the (contemporaneous) relationship between VIX and the overall stock market (as measured by the S&P 500 index), see “On the relationship between the S&P 500 and the CBOE Volatility Index (VIX)“:

Coronavirus: Baylor Finance Expert Explains How Uncertainty is Driving Market Fears

Proud of my Baylor colleague David Dicks, whose recent Journal of Political Economy article entitled “Uncertainty Aversion and Systemic Risk” (cf. provides insights into how uncertainty unleashes waves of investor pessimism; such is the effect that COVID-19 is currently having on financial markets. Dr. Dicks’ advice for investors? “If you are nervous about the impact of coronavirus, do not call your broker. Get a flu shot and be careful about washing your hands.”

In the following Q&A, David Dicks, Ph.D, Baylor University assistant professor of finance, shares his thoughts on why this uncertainty has damaged the markets, puts the current situation in historic perspective and offers hope to investors.

Insurers could lose billions if Tokyo Olympics canceled

Fascinating article about the financial consequences of a hypothetical cancellation of the 2020 Olympics in Tokyo because of the coronavirus…

(Reuters) — Global insurers face a hefty bill if the coronavirus forces the cancellation of the Summer Olympics in Tokyo, with estimates of the cost of insuring the sporting showpiece running into billions of dollars.

The Olympics Were a Petri Dish Long Before the Coronavirus

Something that large scale public events (e.g., major sports events, music festivals, and religious pilgrimages) apparently have in common is the potential to act as de facto transmission hubs with asymptomatic people spreading viruses upon returning home.

The reason that epidemiologists love studying the Olympics: There are few places better at breeding illness. Now the Tokyo Games might be in trouble because of one.

Catastrophe Bonds Signal Coronavirus Nearing Pandemic Status

Fascinating article about how prices of catastrophe bonds issued back in 2017 by the World Bank now show that the coronavirus may very well be evolving into a global pandemic…

Catastrophe Bonds Signal Coronavirus Nearing Pandemic Status
The World Health Organization says the coronavirus isn’t yet a global pandemic. Bonds that insure against just such a catastrophe say that it probably is.

On the Determinants of Risk Aversion

Last week, we began a series of five Finance 4335 class meetings (scheduled for January 28 – February 11) devoted to decision-making under risk and uncertainty. We shall study how to measure risk, model consumer and investor risk preferences, and explore implications for the pricing and management of risk. We will focus especially on the concept of risk aversion. Other things equal, risk averse decision-makers prefer less risk to more risk. Risk aversion helps to explain some very basic facts of human behavior; e.g., why investors diversify, why consumers purchase insurance, etc.

A few years ago, The Economist published a particularly interesting article about various behavioral determinants of risk aversion, entitled “Risk off: Why some people are more cautious with their finances than others”. Here are some key takeaways from this article:

  1. Economists have long known that people are risk-averse, yet the willingness to run risks varies enormously among individuals and over time.
  2. Genetics explains a third of the difference in risk-taking; e.g., a Swedish study of twins finds that identical twins had “… a closer propensity to invest in shares” than fraternal ones.
  3. Upbringing, environment, and experience also matter; e.g., “… the educated and the rich are more daring financially. So are men, but apparently not for genetic reasons.”
  4. People’s financial history has a strong impact on their taste for risk; e.g., “… people who experienced high (low) returns on the stock market earlier in life were, years later, likelier to report a higher (lower) tolerance for risk, to own (not own) shares and to invest a bigger (smaller) slice of their assets in shares.”
  5. “Exposure to economic turmoil appears to dampen people’s appetite for risk irrespective of their personal financial losses.” Furthermore, a low tolerance for risk is linked to past emotional trauma.

Some important intuitions from today’s class meeting of Finance 4335

  1. The most important concept covered in class today is that people vary in terms of their preferences for bearing risk. Although we focused most of our attention on modeling risk-averse behavior, we also considered examples of risk neutrality (where you only care about expected wealth and are indifferent about riskiness of wealth) and risk loving (where you actually prefer to bear risk and are willing to pay money for the opportunity to do so).
  2. Related to point 1: irrespective of whether you are risk averse, risk neutral, or risk loving, the foundation for decision-making under conditions of risk and uncertainty is expected utility. Given a choice among various risky alternatives, one selects the choice which has the highest utility ranking.
  3. If you are risk averse, then E(W) > {W_{CE}} and the difference between E(W) and {W_{CE}} is equal to the risk premium \lambda. Some practical implications — if you’re risk averse, then you are okay with buying “expensive” insurance at a price that exceeds the expected value of payment provided by the insurer, since (other things equal) you’d prefer to transfer risk to someone else if it’s not too expensive to do so. On the other hand, you are not willing to pay more than the certainty-equivalent for a bet on a sporting event or a game of chance.
  4. If you are risk neutral, then E(W) = {W_{CE}} and \lambda = 0; risk is inconsequential and all you care about is maximizing the expected value of wealth.
  5. If you are risk loving, then E(W) < {W_{CE}} and \lambda < 0; you are quite willing to pay for the opportunity to (on average) lose money.

More on the St. Petersburg Paradox…

During today’s class meeting, we discussed (among other things) the famous St. Petersburg Paradox. The source for this is Daniel Bernoulli’s famous article entitled “Exposition of a New Theory on the Measurement of Risk“. As was the standard practice in academia at the time, Bernoulli’s article was originally published in Latin in 1738. It was subsequently translated into English in 1954 and published a second time that same year in Econometrica (Volume 22, No. 1): pp. 22–36. Considering that this article was published 282 years ago in an obscure (presumably peer-reviewed) academic journal, it is fairly succinct and surprisingly easy to read.

Also, the Wikipedia article about Bernoulli’s article is worth reading. It provides the mathematics for determining the price at which the apostle Paul would have been indifferent about taking the apostle Peter up on this bet. The original numerical example proposed by Bernoulli focuses attention on Paul’s gamble per se and does not explicitly consider the effect of Paul’s initial wealth on his willingness to pay. However, the quote on page 31 of the article (“… that any reasonable man would sell his chance … for twenty ducats”) implies that Bernoulli may have assumed Paul to be a millionaire, since (as shown in the Wikipedia article) the certainty-equivalent value of this bet to a millionaire who has logarithmic utility comes out to 20.88 ducats.

Also featured as one of “50 Things That Made the Modern Economy”: The Index Fund

Besides insurance, Tim Harford also features the index fund in his “Fifty Things That Made the Modern Economy” radio and podcast series. This 9 minute long podcast lays out the history of the development of the index fund in particular and the evolution of so-called of passive portfolio strategies in general. Much of the content of this podcast is sourced from Vanguard founder Jack Bogle’s September 2011 WSJ article entitled “How the Index Fund Was Born” (available at Here’s the description of this podcast:

“Warren Buffett is the world’s most successful investor. In a letter he wrote to his wife, advising her how to invest after he dies, he offers some clear advice: put almost everything into “a very low-cost S&P 500 index fund”. Index funds passively track the market as a whole by buying a little of everything, rather than trying to beat the market with clever stock picks – the kind of clever stock picks that Warren Buffett himself has been making for more than half a century. Index funds now seem completely natural. But as recently as 1976 they didn’t exist. And, as Tim Harford explains, they have become very important indeed – and not only to Mrs Buffett.”

Warren Buffett is one of the world’s great investors. His advice? Invest in an index fund