[LINK] Bets do not (necessarily) reveal beliefs

Cyan

When does a bet fail to reveal your true beliefs? When it hedges a risk in your portfolio.

If this claim does not immediately strike you as obviously true, you may benefit from reading this post by econblogger Noah Smith. Excerpt:

...Alex Tabarrok famously declared that "a bet is a tax on bullshit".

But this idea, attractive as it is, is not quite true. The reason is something that I've decided to call the Fundamental Error of Risk. It's a mistake that most people make (myself often included!), and that an intro finance class spends months correcting. The mistake is looking at the risk and return of single assets instead of total portfolios. Basically, the risk of an asset - which includes a bet! - is based mainly on how that asset relates to other assets in your portfolio.

When does a bet fail to reveal your true beliefs? When it hedges a risk in your portfolio.

If this claim does not immediately strike you as obviously true, you may benefit from reading this post by econblogger Noah Smith. Excerpt:

...Alex Tabarrok famously declared that "a bet is a tax on bullshit".

But this idea, attractive as it is, is not quite true. The reason is something that I've decided to call the Fundamental Error of Risk. It's a mistake that most people make (myself often included!), and that an intro finance class spends months correcting. The mistake is looking at the risk and return of single assets instead of total portfolios. Basically, the risk of an asset - which includes a bet! - is based mainly on how that asset relates to other assets in your portfolio.

This is a very good point.

On a related note: I once landed a job considerably better than I thought I would, and was afraid the company might go bankrupt. I was considering buying some puts on it to hedge my exposure, but realised this was probably a bad idea; I would have to disclose my holdings as part of the job, and they would be unlikely to take kindly to my having a massive short position on them. Is there a better way I could have done this?

Well, first, I think that there are ethical issues in trying to hedge your risk from employment. Your risk exposure is beneficial to the company, and the employment is made with an expectation of it. If I hired a lawyer on contingency, and found out that they managed to hedge out all of the risk of losing the case, I would find this behavior quite unethical, to say the least. An employee should not be indifferent to the bankruptcy of their employer.

The being said, there are informal ways of hedging this risk. The biggest is having a social network of peopl... (read more)

0Alsadius13y

Would you have had to disclose a put option position, or a credit default swap?

0gwern13y

Buy shares in competing companies, maybe?

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[LINK] Bets do not (necessarily) reveal beliefs

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[LINK] Bets do not (necessarily) reveal beliefs

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