[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.

Buy shares in competing companies, maybe?

This is unlikely to be a good strategy, because competitive stocks are usually correlated, and market participants see the bankruptcy of one company as possibly foretelling a weak market for the competitors' products also. Unless it's a very specific and unusual situation.

In fact, some think it is best practice for people whose future earnings are highly correlated with a particular market sector to reduce any stock ownership they have in that sector to reduce their risk. E.g. software developers should have portfolios that underweight software or technolo... (read more)

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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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