Risk and Reality --- Some Favorite Quotes

Charlie Munger on Market Risk

"The argument could be made the market in general does not understand the real nature of risk. In a market that was truly efficient, predictability would sell at a premium and stocks of companies whose future was difficult to forecast would sell at a price that reflected risk inherent in that uncertainly. In this world, if Coke's PE was 24, Cisco's PE would be around 3½." --- exact source TBA

The Grand Adventure of Understanding Reality

"I'm reasonably happy, but the money's not the point. It's an indication that I've succeeded in the grand adventure of understanding reality." ---George Soros in response to an interviewer's question.

Persistence of Wishful Thinking

"Wishful thinking can dominate much of the work of a profession for a decade, but not indefinitely."

--- Robert Shiller in "From Efficient Market Theory to Behavioral Finance" (Cowles Commission Report, 2002)

Every Cloud Has a Silver Lining?

“The war situation has developed not necessarily to Japan’s advantage.” --- Emperor Hirohito on the occasion of the surrender of Japan to Allied Forces in 1945 (recently quoted by Paul Krugman in the NYTs; Krugman aimed to tar Bernanke's view of the subprime crisis with a similar brush.)

It's "Just Statistics" without a Face

"Dr. Levy thinks he understands why these prevention strategies are given such short shrift. Prevention, he says, “does not have a face.” There are no personal stories, no individuals who can be pointed to as the success of prevention. It is just statistics." --- Gina Kolata, NYTs, 4/8/07.

Candidate Edwards understands this "face" issue very well, and he certainly has no need for statistics. With such finely honed emotional senses, why should he risk confusing himself with mere data.

Ten Years Of Under Performance?

"Today, investors are loathe to recall that the real total returns on stocks were negative for most 10-year spans during the two decades from 1963 to 1983 or that the excess return of stocks relative to long bonds was negative as recently as the 10 years ended August 1993. " --- Robert D. Arnott and Peter L. Bernstein "What Risk Premium Is 'Normal?" (AIMR, 2002, p. 84)

All true, but perhaps not entirely fair. The ten year bull market in bonds ending in 1993 may have been at least as much of a one-time wonder as the l803-2002 golden age of equities discussed by Arnott and Bernstein.

Small Cap Trouble Ahead?

"It's pretty hard to see how margins can expand in an environment that produces a 2.5% increase in gross domestic product," --- Arnie Schneider, manager of Schneider Small-Cap Value.

Schneider is tied with three others with the best winning streak against the SP500, and he sees little hope for small caps to out perform big caps over the next year. (11/07)

His statement also suggests a testable principle. Take years where the ex-ante consensus forecasted growth rate was below historical median. How often did the small caps out perform? My guess is that Mr. Schneider has history on his side.

You may not be a believer in history lessons, but when the VIX is high and the CBOE Put/Call ratio is high, small cap value has historically been, shall we say, an unhappy holding. If you are a style box kind of person and you are not heading for the hills, then you might head for large cap growth.

2.5% Not Bad; I'd take it (12/20/2007); Looks like 0% or maybe less (5/22/2008).

Rational Forecasts

"One characteristic of a rational forecast is that it should be less variable than the object being forecasted." ---Kevin J. Lansing writing in the FRBSF Letter (10/26/07)

Lansing reprises Shiller's argument that the stock market is "too volatile" when compared to the rational model that says current stock price is a forecast of the present value of the future returns.

More Cognitive Biases?

Confirmation Bias

"If you were taught that elves caused rain, every time it rained, you'd see the proof of elves. "--- Ariex (via Terrence Tao's quote page)

Another that I like comes via Tao:

"There are two rules for success: (1) Never tell everything you know..." --- Roger Lincoln

WMD ... No Doubt

"Simply stated, there is no doubt that Saddam Hussein now has weapons of mass destruction. There is no doubt that he is amassing them to use against our friends, against our allies and against us." --- Vice Pres. Dick Cheney, August 26, 2002 http://www.msnbc.msn.com/id/18094428/

OOPS...and see next quote

A Man's Two Reasons

A man always has two reasons for the things he does --- a good one and the real one. --- J. Pierpont Morgan

Quoted by Ron Chernow in The House of Morgan, p. 114, after telling about "closed door" peccadillo's of Charles Schwab, the Schwab that served as the first CEO of U.S. Steel --- not the discount broker.

Statistics and the Law

"An attorney who treats a client like a hypothesis would be disbarred; a Ph.D. who advocates a hypothesis like a client would be ignored."

--- Lee Epstein and Gary King (Chicago Law Review, 2002)

Advice to a Young Bookie

Life is pretty random, but not purely random --- not 50-50.

Your job every day is to sort out the 51s from the 49s, or at least the 60s from the 40s, and never ever should you forget that a 95 is not a 100.

No quotes --- I'll suffer the blame.

Next Square Meal?

"In all of recorded history there has not been one economist who had to worry about where his next meal was coming from." ---- Peter F. Drucker

More Misspecified Loss Functions

"I'm amazed. Some people take better care of their cars than their bodies. It's weird." --- Cardiologist Charles Karaian

“It’s taken me all my life to learn what not to play.” --- Dizzy Gilespie, Jazz Master

For me this is a telling quotation. Statisticians are often asked to do what simply cannot be done.

It is all too human to offer false hope: "Oh, sure, we can do something here."

It takes a lifetime to learn to say, "Sorry, Friend, this is not possible. You ask too much of our modest tools."

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