Step aside volatility, ambiguity is the new way to measure risk.
The VIX, a volatility index, has been a popular tool for measuring risk for just over 20 years. But investor emotion, and the need to sleep well at night, matter just as much in asset allocation. Welcome, ambiguity.
Take for instance the average U.S. investor. They’re generally overweight in U.S. equities, despite the fact that the risk of international stocks is pretty much the same. Investors are more comfortable with the risk they know, rather than the risk they don’t know, even though it’s the same, explains Lawrence Solomon, chief financial officer at Exceed Investments.
Ambiguity plays into daily investment decisions whether investors realize it or not, so why not make it another quantifiable measurement, asks Joseph Halpern, CEO of Exceed. Investors assume the greater the risk they take, the greater the potential payout. The fear associated with ambiguity is what leads to investors buying high and selling low.
Even though few people consciously look at ambiguity, it’s pretty much a big deal, says Halpern. Even one of the VIX creators, Prof. Menachem Brenner of the NYU Stern School of Business, is examining ambiguity aversion by investors and ambiguity as the next indexable measurement. If people have turned to rely so much on VIX, an ambiguity index shouldn’t be such a strange concept, says Halpern. “Someone is going to quantify it,” says Halpern. “It’s simply too impactful.”
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