In investing, ‘risk’ can have many meanings: the risk of inflation, the risk of interest rates changes, the risk of currency exchange rate fluctuations, just to name a few.

One important measure of the riskiness of a stock (or mutual fund) is: How much does its value change relative to other stocks?

Which would you rather own?

Below is a graph of the S&P 500 index and the total return on a bond fund (PTTDX: Pimco Total Return).  Each line was normalized to 1 at the beginning.  If you made either investment in June 2002 and held it for six years, you would have had about a 35% total return on your investment.  Both investments end up at the same point.

Continue Reading »

The concept of risk underlies much of finance.  We expect that riskier investments will have higher returns.  The riskiness of a corporate bond is one of the main determinants of its price.  But measuring — truly quantifying — risk is hard to do.

Sure, companies like Moody and Fitch assign companies risk letter grades akin to schoolgrades.  But, in college, my sister used to bake brownies for her teaching assistant to get better grades.  And if brownies can give one a boost, just imagine what you can get for the millions of dollars paid by the companies being rated to the companies doing the ratings.  It’s not hard to see (in hindsight) why we’re in the mess we are today.

Enter Freerisk.org.  A couple of slide-rule wielding financial guys who want to throw open the data and crowdsource a better solution.

While I applaud their intentions, isn’t asymmetric data the root problem?  Only the guys inside the company know the true financial picture.  The data reported in the SEC filings are the most optimistic view (within GAAP) of the true situation.  If the data is skewed, how can the result be straight?

I am intrigued by the creation of a large public financial dataset.  Could one use it to investigate things other than risk?  Expected market returns?  Geopolitical stability?  The flow of illicit funds?  If you’re interested, there a Google group forming –get in on the ground floor.

Tip ‘o the green shade to Wired Magazine (June 2009, p. 28) and to Garrison Keillor’s Lake Wobegon for the title phrase.

Photo credit:  Flickr