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Pandora’s Risk: Uncertainty at the Core of Finance Page 1 (21 of 304)
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1
Introduction
Th nance. It’s the risk is is a book about the most important risk we face in fi
that comes from learning about risk. I call it Pandora’s risk in honor of
legend’s prime culprit. If she hadn’t opened the box of wealth and woe, we’d
have no hunger to learn.
Other fi elds involve learning too. Since the observer never fully un-
derstands the observed, there’s always something to learn. Occasionally,
learning overturns some core beliefs. Th c revolutions at’s how scientifi
occur.
Finance stands out in that the core objects of study are themselves
observers. Market participants rarely know the true value of what they’re
trading. Markets grope for knowledge by aggregating individual beliefs.
But beliefs are constantly shift ing.
Twentieth- century fi nance theory treated learning as a sideshow. It
assumed that the market consensus largely captured the true risks. Error
was dirt around the edges. If the dirtballs got big enough, speculators
should arbitrage the discrepancies and clean things up.
In reasoning this way, theorists missed something that every market
practitioner knows. Most speculators don’t trade on changes in risk. Th ey
trade on changes in beliefs about risk. Th ose aren’t the same. Sometimes
they’re not even close.
