November 4, 2008

Behind AIG's Fall, Risk Models Failed to Pass Real-World Test -

Behind AIG's Fall, Risk Models Failed to Pass Real-World Test -

A great article about AIG reckless underwriting of credit default swaps. The article is a great illustration on the difference between risk and volatility. I have argued this difference in several posts and I still believe that a lot of investors, even professional, as illustrated by this article, confuse risk and volatility.

Several take away from the AIG case:

  1. Models do not articulate risk, they articulate volatility.
  2. Common sense and conservative policies go along way in protecting capital.
  3. Historical data should not be relied on for investment decisions entirely; it can always be manipulated to show whatever case you want them to show.
  4. Good and conservative management matter much more than assets and technology.


Neil said...

It's worse than that. An investment course I took at the local university actually taught that Risk=Volatility. Not just confused about what the difference might be, but actually teaching that there was no difference.

Sami said...

yes I forget all about academia. everything in finance courses revolve around Std deviation as measure of risk which completely absurd.

in this type of science, finance, I want to learn from practitioners like Buffet.

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