Category Archives: The Real World

How Do Energy Companies Measure the Temperature? Not in Fahrenheit or Celsius

Instead of Fahrenheit or Celsius, a metric called “degree days” is used to capture variability in temperature. The risk management lesson here is that this metric makes it possible to create risk indices which companies can rely upon for pricing and hedging weather-related risks with weather derivatives.

How Hurricane Florence Could Move Insurance Markets

Hurricane Florence provides a particularly timely and compelling case study of the economic consequences of natural catastrophes; specifically, the nexus of direct and indirect effects upon property insurance markets, reinsurance markets, alternative risk markets (e.g., catastrophe bonds), and public policy.

Some hurricanes are worse than others — both for people in the way and the insurance industry that tries to understand storms and put a price on their risks.

Confirmation bias in the form of “information avoidance”

This article from the Wall Street Journal provides an interesting follow-up to yesterday’s behavioral finance discussion. “Information avoidance” represents a particularly strong (and potentially deadly) form of confirmation bias!

Getting past information avoidance to deal with health issues, financial difficulties and other worries.

Your Tolerance for Investment Risk Is Probably Not What You Think

This (year-old) WSJ article is authored by Professor Meir Statman, the Glenn Klimek Professor of Finance at Santa Clara University. Professor Statman’s research focuses on behavioral finance, which is a very important topic in decision theory that I plan to cover during next Tuesday’s meeting of Finance 4335.

Your Tolerance for Investment Risk Is Probably Not What You Think

The questions financial advisers ask clients to get at the answer actually measure something completely different—often leading to misguided investment strategies.

On the Determinants of Risk Aversion

Four years ago, The Economist published a particularly interesting article about the 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.

What Will Trigger the Next Crisis?

Following up on my previous blog posting entitled “The world has not learned the lessons of the financial crisis”, today’s “Heard on the Street” column in the Wall Street Journal entitled “What Will Trigger the Next Crisis?” is required reading! Both articles are motivated by the fact that we are now ten years out from the bankruptcy (on September 15, 2008) of Lehman Brothers. Many commentators mark this day as the seminal event for what is now commonly referred to as the so-called “Global Financial Crisis of 2008” – widely considered to have been the worst financial crisis since the Great Depression of the 1930s.