Market Risk and Efficiency
Taming Global Village Risk
July 1, 2008
Topics - Market Risk and Efficiency
The Journal of Portfolio Management
Asset price bubbles have been part of modern capital markets since those markets first evolved some 300 years ago. Bubbles build and burst today much as they did then. Recently, however, the real economy has become less volatile, but financial markets have not; they remain volatile and unpredictable.
Why is this? What forces are driving market volatility? Answering those questions would provide investors a basis for an effective response in dealing with market risk.
Markets are, in effect, complex adaptive systems. They are composed of legions of decentralized decision makers who are continually digesting information and interacting in unanticipated and nonlinear ways. That markets are complex adaptive systems has critical implications for how we think about and manage investment risk.
In risk management, we must focus on the market mechanisms driving capital markets to higher volatility, including the emotions of investors, complexity of adaptive markets, advances in technology and improved mathematical modeling.
To ramp up risk management we need to find new tools to measure the interconnectedness of markets as well as the total amount of systemic risk, leverage and liquidity in the markets. With improvements in risk management, investors and regulators will be better equipped to mitigate the market volatility that often culminates in financial market instability.
This document is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein.
This document has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and AQR Capital Management, LLC (“AQR”) to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. This document is not to be reproduced or redistributed to any other person. The information set forth herein has been provided to you as secondary information and should not be the primary source for any investment or allocation decision. Past performance is not a guarantee of future performance. Diversification does not eliminate the risk of experiencing investment losses.
This material is not research and should not be treated as research. This paper does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of AQR. The views expressed reflect the current views as of the date hereof and neither the author nor AQR undertakes to advise you of any changes in the views expressed herein.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither AQR nor the author guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Diversification does not eliminate the risk of experiencing investment losses.
The information in this paper may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.