Rethinking risk

Javier Estrada ()
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Javier Estrada: IESE Business School

Journal of Asset Management, 2014, vol. 15, issue 4, No 3, 239-259

Abstract: Abstract Volatility is the most widely used measure of risk but its relevance is questionable in many settings. For long-term investors, short-term volatility is a nuisance they just have to live with and disregard as much as possible. Tail risks, however, are critical because, although rare by definition, they have a large impact on terminal wealth. Using a comprehensive sample that spans over 19 countries and 110 years, this article argues that when 1, 5 or 10 per cent tail risks strike, stocks offer long-term investors better downside protection than bonds in the form of a higher terminal wealth. In fact, stocks offer both a higher upside potential and better downside protection than bonds, even when tail risks strike. Hence, their higher volatility essentially is higher upside risk; that is, uncertainty about how much better, not how much worse, long-term investors are expected to fare with stocks rather than with bonds.

Keywords: risk; volatility; downside potential; stocks versus bonds; time diversification (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1057/jam.2014.21

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