unknown unknown unknowns

I had a couple of interesting discussions with hedge fun friends this past weekend, who are fairly concerned with the latest bit of bad news (incidentally, one noted that people who invest in funds that invest in funds are, in fancy financial terms, ‘morons’).

More interesting was a bit of thought on how much risk firms are taking on. HF friend, whose firm is sitting on lots of cash at the moment (well, probably treasuries, but more or less same thing), suggests that they can’t really tell clients how much risk there is in the markets because they don’t really know. He doesn’t know, so to try to translate something like a summary statistic (Value at Risk) is at best misleading. I’ve written before about ambiguity, and this is what he’s getting at. With (equity) markets moving 10% a day, and things like Madoff basically ponzi scheming his way to $50 billion losses, it is impossible to assess risk well enough to do anything. And in absence of anything even resembling stability, cash makes sense.

And in the same spirit, over at Paul Wilmott’s blog, he has a good discussion of scenario risk analysis, told well through card tricks.

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