The Investment Scientist

Warren Buffet: Volatility does not measure risk

Posted on: April 23, 2008

Volatility does not measure risk. The problem is that the people who have written and taught about risk do not know how to measure risk. Beta is nice because it is mathematical, it is easy to calculate and it is wrong – past volatility does not determine the risk of investing. In early 1980s, farmland that had gone for 2,000 an acre, went for $600 an acre. Beta shot up. I was apparently buying a riskier asset at $600 than at $2,000. Real estate not frequently traded. Stocks give you the ability to measure this volatility nonsense.

Because people who teach finance use the mathematics that they have learned, they translate volatility into all types of measures of risks — it’s nonsense. Risk comes from the nature of certain types of business, and from not knowing what you’re doing. If you understand the economics of the business that you’re engaged in and you trust the people you are partnering with, you’re not running significant risk.

Volatility as risk has been very useful for those who teach, never useful for us.

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2 Responses to "Warren Buffet: Volatility does not measure risk"

well, it’s all mixed up !!! Buffet is an investor and not a trader and therefore it is normal he prefers the accounting approach to a more quantitative one.
If you are investing like Buffet does then it is good having a look at balance sheets and income statements but if you are a day trader or a position trader Buffet’s statement is just nonsense.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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