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Off topic: In portfolios, risk can be reduced via diversification without being transferred: https://en.wikipedia.org/wiki/Modern_portfolio_theory#Systematic_ri

Off topic: In portfolios, risk can be reduced via diversification without being transferred: https://en.wikipedia.org/wiki/Modern_portfolio_theory#Systematic_risk_and_specific_risk https://en.wikipedia.org/wiki/Modern_portfolio_theory#System...

richardwhiuk 12y ago
Can you give a specific example? It seems to me you can either share out risk, or place a bet to offset the risk, in which case you have transferred the risk to the person taking the bet at some price. They may be taking / placing yet another bet, but that simply moves it on further. To make it concrete, if I buy a house, and there's a chance that it'll fall down this year and I'll loose the 100k , then after a year is up, if it's fallen down the sum of whatever portfolio it's been distributed in is still down 100k.
- seanflyon 12y ago
  If you buy a small piece of many houses you have much less uncertainty because it is incredibly unlikely that they will all fall down. The total loss is the same but it is spread out so much that it averages out and becomes much more predictable. It reduces volatility (which is often referred to as "risk") but I think you are correctly pointing out that it does not change the average outcome.
  - gaius 12y ago
    Or if you buy a small piece of many mortgages... Oh wait
    - vegabook 12y ago
      ha - brilliant. The fallacy of "diversification" is that it only transfers risk intertemporaly. Ultimately someone will get shafted double or more at some stage - it's just a question of arbing the unstable correl matrix while you can... which can and will go to a fully populated matrix of (abs)1s at some unfortunate stage when you (they!) are left holding the baby. You're left hoping that you'll have been paid a few bonuses before that happens....
      - seanflyon 12y ago
        The point of diversification is that no one gets shafted because lots of people are left holding the the "baby" together. It does not reduce the total amount of loss but it trades a 1% chance of losing $50 with a 50% chance of losing $1.
        vegabook 12y ago
        sure but when correlations go to 1, you're as badly off as if you only had one position. Diversification engenders false senses of security, and moreover, means everybody has a bit of everything. Therefore mass panic can ensue causing the correl matrix to ramp. See: 2008. I contend that diversification makes for great maths, but often poor risk management.
  - richardwhiuk 12y ago
    Assuming that none of your risk is uncorrelated - which is not as true as people wish or hope. E.g. if you buy a huge number of San Francisco you are now very exposed to large earthquakes, or the house price in SF falling due to a tech bubble

richardwhiuk 12y ago

Can you give a specific example? It seems to me you can either share out risk, or place a bet to offset the risk, in which case you have transferred the risk to the person taking the bet at some price. They may be taking / placing yet another bet, but that simply moves it on further. To make it concrete, if I buy a house, and there's a chance that it'll fall down this year and I'll loose the 100k , then after a year is up, if it's fallen down the sum of whatever portfolio it's been distributed in is still down 100k.

seanflyon 12y ago
If you buy a small piece of many houses you have much less uncertainty because it is incredibly unlikely that they will all fall down. The total loss is the same but it is spread out so much that it averages out and becomes much more predictable. It reduces volatility (which is often referred to as "risk") but I think you are correctly pointing out that it does not change the average outcome.
- gaius 12y ago
  Or if you buy a small piece of many mortgages... Oh wait
  - vegabook 12y ago
    ha - brilliant. The fallacy of "diversification" is that it only transfers risk intertemporaly. Ultimately someone will get shafted double or more at some stage - it's just a question of arbing the unstable correl matrix while you can... which can and will go to a fully populated matrix of (abs)1s at some unfortunate stage when you (they!) are left holding the baby. You're left hoping that you'll have been paid a few bonuses before that happens....
    - seanflyon 12y ago
      The point of diversification is that no one gets shafted because lots of people are left holding the the "baby" together. It does not reduce the total amount of loss but it trades a 1% chance of losing $50 with a 50% chance of losing $1.
      - vegabook 12y ago
        sure but when correlations go to 1, you're as badly off as if you only had one position. Diversification engenders false senses of security, and moreover, means everybody has a bit of everything. Therefore mass panic can ensue causing the correl matrix to ramp. See: 2008. I contend that diversification makes for great maths, but often poor risk management.
- richardwhiuk 12y ago
  Assuming that none of your risk is uncorrelated - which is not as true as people wish or hope. E.g. if you buy a huge number of San Francisco you are now very exposed to large earthquakes, or the house price in SF falling due to a tech bubble