Saturday, October 10, 2009

Crisis Lessons: Presentation...

A few posts ago, I mentioned that I was working on a presentation reflecting the lessons that I learned from the crisis. I had also promised to post the presentation when it was ready. You can get it be clicking on the link below:

Market Revelations: Lessons learned, unlearned and relearned from the Crisis

While you can read about the specific lessons that I have taken away from the last year in the presentation, here are the general points I want to make:

1. These are the lessons that I have learned. In other words, this is my personal odyssey and I do not expect everyone to have learned these lessons, nor do I feel the urge to impose them on others.

2. The common theme across the many lessons is that I am much more wary about using past or historical data, whether it be at the company level (profitability, risk etc.) or at the macro level (equity risk premiums). Mean reversion, i.e., the assumption that numbers revert back to historical averages, has served us well, at least in developed markets for a long time, but a blind adherence to it can decimate companies and portfolios.

3. At a gut level, I feel that I have a better understanding of risk and the need for risk premiums now than before the crisis. Fundamentally, I believe that this crisis was precipitated by a belief that we can measure and control risk, when the nature of risk is that it cannot be ever fully measured or controlled.

4. I would not classify myself as a behavioral economist, but I am more willing to give behavioral finance a place at the table when we think about solutions to corporate finance and investment problems, after the crisis, than before.

The bottom line is that I feel humbled by all the things I do not know about finance and markets and excited at the prospect of exploring these things more.


Compendium said...

I have not gone through the presentation, but I feel that behavorial aspect of finance needs to be explored. Unlike real sciences (physics, mathematics, chemistry), finance is definitely a social science. Financial accounting is "generally accepted" (GAAP), and so are the models that comprise the financial innovation. To get to a level of general acceptance, you need some degree of logic but then the social aspect takes over. Schools should include courses in social psychology along with financial mathematics.

Aswath Damodaran said...

I agree but I also know that understanding how human beings behave is not going to necessarily give me a better handle on predicting that behavior.

Pallav said...

The basic aspects of human nature do not change and one has to be dispassionate enough to understand when he/she is being subjected to the vagaries of his/her nature, so that he/she can act accordingly to counter that nature. I have been hearing that it was the way the risk was distributed in the so called developed markets that the extent of its impact was not realized. This was again due the ingenious human mind which finds ways to break rules however much you may set them in stone. Perhaps behavioural finance might help but I feel predicting the future is the most elusive thing,in hindsight however much we feel we might have predicted it, it just eludes us.