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Buzz & Banter


Good morning. At this moment I'm sitting in the direct center of the projected path of Hurricane Isabel. What is worse, it still takes me over an hour to get to the beach on a traffic-free day. That's a perfect example of complete exposure to all of the risks and downside of beach living (i.e. hurricanes), with none of the upside (i.e. actual beach).

Speaking of risk, in the Wall Street Journal this morning there is an article on a bond fund manager that lost $1.2 million on a single day in July. The bond fund manager is quoted as saying he didn't realize the loss could happen so dramatically. Yes, that's kind of the point of risk management, isn't it, preparing for the possibility that something could happen much more dramatically than we anticipate?

Individuals take heart; even professional investors tend to dramatically underestimate financial market risks. Those who live in coastal areas know all too well about the potential risks of the 100-year storm. From time to time here I've shown a simple bell-shaped distribution of the risk level of the sectors we follow. The 100-year storm is the outlier event that falls at the extreme tails of a bell shaped curve. A "normal" distribution curve will be very tall at the center and drop off dramatically as you move away from the mean.

Those who play financial markets are also aware of the 100-year storm. Unfortunately, in financial markets, because the normal distribution curve is more flat in the center with pesky fat tails at the ends, 100-year storms occur with a far greater frequency than 100 years, and with a far greater frequency than most market participants ever anticipate.

The Yale survey Toddo mentioned this morning certainly is further evidence of the market's short memory.
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