A Brief Primer On Risk Management

We say ‘brief’ because the first hurdle one has to clear when assessing any type of situation is whether or not there is risk involved. Risk can appear anywhere – even when crossing the street. Such simple acts are rarely given much consideration, but our brains are constantly analyzing risk/reward quotients for various activities.

Often, when looking at investments, we give in to perceptions rather than realities. Most capital asset pricing models, for instance, rely on the use of ‘the riskless asset’ in their various formulas. Does such an asset exist, or is it akin to the ‘Giffen good’ concept in mainstream economics texts?

If anything has become clear since the turn of the century, it is that there is no such thing as a ‘riskless asset’. US Government debt, the de facto 'AAA' rated standard bearer of zero risk, has become fraught with uncertainty. Once we break the mental model that there are in fact safe havens, we can start to have a meaningful conversation about risk and reward.

Before we launch into a series of short briefs outlining the various types of risk, we need to hit some assumptions. These assumptions are especially true for Americans, and anyone who holds depreciated US Dollars in any real quantity.

The Dollar is the reserve currency of the world. At present time, this is an arrangement of convenience more than anything else. Why would anyone want a paper ticket (which is mostly digital now) that has no intrinsic value, does not act as a store of wealth, and has developed such an animus about it?

Answer: because that’s what we’ve always done. The population of the world, in vast majority, hasn’t lived through a time when the Dollar wasn’t the standard bearer. So it is human nature to assume this will continue – despite mounting evidence to the contrary. If we make the leap that the Dollar is vulnerable, then so does all the debt that bears its name. Goodbye says the ‘riskless asset.'

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