The Many Faces of Risk

The only way to get really close to understanding risk is to combine many different indicators of the concept

Eric Jacobson 31 May, 2011 | 5:04PM
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Sometimes it seems as though all we ever discuss and write about is risk. In talking with investors who were burned during the most recent crisis and are now worried about the next one over the horizon, however, it's clearly never a bad time to rekindle some old flames of the discussion.

Unfortunately, the very definition of risk is elusive, as it can take on different shades of meaning depending on who's using the word. Here's a framework to think about it. These aren't widely accepted academic terms--just some labels to try and make the case.

True Risk
Sheesh. Where to even start? One of my colleagues invoked Justice Potter Stewart's famous declaration (about obscenity): "I shall not today attempt further to define ... [it]; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it." Think of "True Risk" as the hypothetical, inherent risk in an investment--in other words, a Platonic ideal: The risk that exists, whether it's ever actually realised or not, and which any of us could only be certain of if we had perfect, godlike knowledge. Put another way, we're talking about risk that can never be truly and completely known or measured unless it rears its head and comes to fruition.

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Eric Jacobson  is director of fixed-income research with Morningstar.