Against the Gods: The Remarkable Story of Risk

Chapter 15

The Strange Case of the Anonymous Stockbroker

This chapter deals specifically with how to measure risk when we invest in securities. Impossible as that may sound, quantification of investment risk is a process that is alive, well, and regularly practiced by professionals in today’s world of globalized investing. Charles Tschampion, a managing director of the $50 billion General Motors pension fund, recently remarked, “Investment management is not art, not science, it’s engineering. . . . We are in the business of managing and engineering financial investment risk.” The challenge for GM, according to Tschampion, “is to first not take more risk than we need to generate the return that is offered.”1 A high degree of philosophical and mathematical sophistication lies behind Tschampion’s words.

Throughout most of the history of stock markets—about 200 years in the United States and even longer in some European countries—it never occurred to anyone to define risk with a number. Stocks were risky and some were riskier than others, and people let it go at that. Risk was in the gut, not in the numbers. For aggressive investors, the goal was simply to maximize return; the faint-hearted were content with savings accounts and high-grade long-term bonds.

The most authoritative statement on the subject of risk had been issued in 1830 and had been purposefully vague.2 It appeared in ...