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dangerColombia - Aswath Damodaran 1 Danger and Opportunity:...

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Unformatted text preview: Aswath Damodaran 1 Danger and Opportunity: Risk: What is it, how do we measure it and what do we do about it? Aswath Damodaran Aswath Damodaran 2 Risk is ubiquitous and has always been around Risk has always been part of human existence. In our earliest days, the primary risks were physical and were correlated with material reward. With the advent of shipping and trade, we began to see a separation between physical risk and economic rewards. While seamen still saw their rewards linked to exposure to physical risk scurvy, pirates and storms wealthy merchants bet their money on ships returning home with bounty. With the advent of Fnancial markets and the growth of the leisure business, we have seen an even bigger separation between physical and economic risks. Aswath Damodaran 3 Agenda What is risk? Why do we care about risk? How do we measure risk? How do we deal with risk in analysis? How should we manage risk? Aswath Damodaran 4 I. What is risk? Aswath Damodaran 5 The slippery response play with words.. In 1921, Frank Knight distinguished between risk and uncertainty by arguing if uncertainty could be quantied, it should be treated as risk. If not, it should be considered uncertainty. As an illustration, he contrasted two individuals drawing from an urn of red and black balls; the rst individual is ignorant of the numbers of each color whereas the second individual is aware that there are three red balls for each black ball. The rst one, he argued, is faced with uncertainty, whereas the second one is faced with risk. The emphasis on whether uncertainty is subjective or objective seems to us misplaced. It is true that risk that is measurable is easier to insure but we do care about all uncertainty, whether measurable or not. Aswath Damodaran 6 More risk semantics Risk versus Probability : While some defnitions oF risk Focus only on the probability oF an event occurring, more comprehensive defnitions incorporate both the probability oF the event occurring and the consequences oF the event. Risk versus Threat : A threat is a low probability event with very large negative consequences, where analysts may be unable to assess the probability. A risk, on the other hand, is defned to be a higher probability event, where there is enough inFormation to make assessments oF both the probability and the consequences. All outcomes versus Negative outcomes : Some defnitions oF risk tend to Focus only on the downside scenarios, whereas others are more expansive and consider all variability as risk. Aswath Damodaran 7 Or hiding behind numbers Aswath Damodaran 8 Here is a good defnition oF risk Risk, in traditional terms, is viewed as a negative. Websters dictionary, For instance, defnes risk as exposing to danger or hazard. The Chinese symbols For risk, reproduced below, give a much better description oF risk The frst symbol is the symbol For danger, while the second is the symbol For opportunity, making risk a mix oF danger and opportunity. Aswath Damodaran 9 Lesson 1: Where there is upside.....
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dangerColombia - Aswath Damodaran 1 Danger and Opportunity:...

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