The Long View of Financial Risk

Jan 4, 2010

An extended history of market returns reveals aspects of financial risk that are not evident over short timescales. The most enduring risk measure is variance, which quantifies short-term regularities in return dispersion. An alternative measure, shortfall, quantifies the risk of extreme market moves, and calls for a deep history to inform its forecasts. Both variance and shortfall are convex, meaning that they tend to promote diversification and can be used in optimization. By offering a long-view counterpart to variance, shortfall can significantly broaden an investor's risk perspective.