Peter Bernstein is an elder statesman of finance. He
served time in the rough-and-tumble world of portfolio management. He
was the first editor of the Journal of Portfolio
Management, and his diverse writings have made him somewhat the
chronicler of twentieth century finance. He is best known for his book
Capital Ideas: The Improbable Origins of Modern Wall Street A problem with being a bestselling author is the
fact that you have an editor who wants you to do it again.
Bernstein, with some coaxing, has published several more books that have
never matched the brilliance of Capital Ideas. One of these was
Against the Gods: The Remarkable Story of Risk Since then, Bernstein has frequently commented on risk, and it has been interesting to watch his ideas evolve. It is as if he first wrote the book on risk and later became an expert. Perhaps the most telling indication of how far his thinking has come from the risk-measurement focus of Against the Gods are remarks he made at a CFA Institute symposium in February 2006: I am increasingly concerned with how the risk management business today focuses so intently on the tools of risk measurement—probability, normal curve, sampling, regression to the mean, mean-variance. To me, risk management is not about measurement at all. It is about how we make decisions and only incidentally about the math we use in making those decisions. If we stare at just the models and equations, we lose sight of the mystery of life—we lose sight of the unknown. There would be no such thing as risk if everything were known. If only a finite number of things could happen, risk would not exist. Even the most brilliant mathematical genius will never be able to tell us what the future holds. What matters in thinking about risk is the quality of the decisions we make in the face of uncertainty. I have long held a similar view. In my 2004 paper Defining Risk, I concluded that it is impossible to define risk. We speak intuitively of risk, but there is no "true risk." At best, we can define perceived risk—a far less compelling notion. Risk metrics such as volatility, delta or value-at-risk, are really metrics of perceived risk. In my paper, I elaborated: What is risk? How can we quantify risks that cannot be perceived? If a trader or business manager has knowledge that is not reflected in a risk metric, does the risk metric misrepresent risk? In the absence of true risk, these questions are empty. A more practical question is whether a risk metric is useful. Used in a given application, will it promote behavior that management considers desirable? So why discuss Bernstein now? He has a new book out
called
Capital Ideas Evolving Glyn A. Holton
|
. It is a
wonderful book that introduces readers to modern finance
theory. Many books do the same thing through weighty mathematics.
Bernstein did it with fascinating historical narratives.
. Tacitly identifying risk with risk measurement,
this was largely a
non-technical history of the development of probability theory. There
are better histories of probability theory, but this didn't matter. Bernstein was a star, and the book sold healthily. 
.
This is a follow-up to Capital Ideas. Picking up where the
earlier book leaves off, it focuses on subsequent developments in both
finance theory and practice. Bernstein's new thinking on risk is
front-and-center. Indeed, I now perceive his comments at the 2006
symposium as just a preview.
