The Universal Principle of Risk Management: Pooling and the Hedging of Risks – Yale, ECON 252, 2.2
Posted on | January 29, 2009 | 2 Comments
This is synopsis two of two from lecture two of Dr. Shiller’s Yale ECON 252 course: Financial Markets. Go to the ECON 252 link to access all synopses to this point.
Correlation is important because it shows how closely related a group of data is. Correlation is illustrated as a number between -1 and 1. The closer to 1, the closer the correlation or relationship and the closer to -1, the weaker the relationship. A regression line is drawn through a set of data to minimize the sum of the squared distances. The intercept of the y axis of this line is the Alpha and the slope of the line is Beta. The beta of an investment shows how the investment does with the market while the alpha shows if the investment outperforms or under performs.
A normal distribution curve is a bell shaped curve. There are many different instances of a bell shaped curve including a fat tail distribution. The idea of a fat tail distribution is that one can stay within a set of data for 20 years before they see one major outlier. This often happens with investments as an investors averages 6% returns for 20 years and then sees a 64% return. This is often thought of as the “black swan” because it rarely happens but is possible.
Present value is the amount something is worth now compared to the future. The value of a dollar today is worth less than it is a year from now because that money could be invested and would receive interest. An example of an investment with present value is a perpetuity. A perpetuity pays a fixed amount of money for a certain period forever. Most of the time, an interest rate is given with each individual payment. An annuity is another example. The most common example of an annuity is a mortgage. There are a certain number of payments that occur and when the payments conclude in x amount of years, the annuity has completed.
Diminishing marginal utility is the idea that as someone makes more money, they are less likely to cherish or value each dollar as much. If someone is making $100,000, they are less likely to value a dollar in the same way as someone who makes $35,000. The diminishing marginal utility curve is upward sloping and concave down. It rarely, if ever, decreases, but it does get flatter in time as an individual makes more money than they can use.
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January 30th, 2009 @ 11:42 am
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January 31st, 2009 @ 7:22 am
“The value of a dollar today is worth less than it is a year from now because that money could be invested and would receive interest.”
Is this true during a period where the inflation rate exceeds the investment rate of return (especially once risk is factored into the ROI calculations)?