Is this ‘Risk’?

My question is: is this fall really about risk repricing or is the phrase merely a fig leaf? Going back to Finance 101, I recall that risk is something that can be priced. Our friends in the insurance sector would vouch for that and deliver complex equations to show just how. If the industry can sell health, earthquake, keyman, kidnapping or currency fluctuations, it can well insure — and price — any risk, including the current one. “Risk,” as Frank H Knight noted as far back as 1921 in Risk, Uncertainty, and Profit, is when “future events occur with measurable probability”. The keyword here is ‘measurable’.

The next question, therefore: was the subprime mess and the resultant meltdown measurable? I think not. Does anyone know the extent of the subprime fallout? No. Experts put the figure between $50 billion and $500 billion. As a corollary, does anyone know its impact on house price crash? No. According to research by international macroeconomics expert Nouriel Roubini, professor of economics at New York University’s Stern School of Business and chairman, RGE Monitor, the fall could be 10 per cent. Others throw different numbers.

Or ‘Uncertanity’?

What are we dealing with? The answer: uncertainty, defined by Knight as the likelihood of future events being “indefinite or incalculable”. When the impact of an event is incalculable, it can no longer be priced. Generally, ROR is a calculation by global funds to see how much risk they can take to get the higher returns from emerging economies like India, Brazil, China, Turkey and Russia. If the FED raises rates, ROR is calculable. At 5.25 per cent, the US risk free return is higher than India’s 5 per cent India’s markets are offering (risk, in this case, defined as the inverse of PE which stands at 20).

... contd.