Liability-Driven Investment

CHAPTER 2Introduction to Investment Risk

The key question when analysing financial assets is what are the risks? But what is risk? Well, this depends on who you ask. Skydiving is ‘risky’ but in a different way, so is walking down the street. Some investors will avoid the stock market, because it's risky, but may occasionally gamble on sports, or they might leave cash in the bank or under the couch where it's value could be whittled away by inflation. One thing we can agree on though, is that:

‘Risk is a four letter word!’

(In the English language, at least)

No book on investment, liability driven or otherwise, would be complete without gently circling the idea of investment or financial ‘risk’ and attempting to define it. Risk is in many ways a strange word, the very concept of risk can and will mean different things to different people at different times in their lives. Users and abusers of financial services will have markedly different perceptions of what ‘risk’ is, what ‘risk’ was and the risks ahead. Even across different sectors of the investment industry what a practitioner may consider as ‘risk’ can also differ markedly.

Unhelpfully, the securities markets and financial market practitioners everywhere, alongside the world of financial risk management, have created many multiple definitions of risk which can add to, but also sometimes confuse our real-world understanding of the concept. It will be shown that risk is a word that is difficult to define exactly and has ...