Quick, which would you prefer, ¥10 000 with certainty, or a 50% chance of getting ¥20 000?
You can’ t even trade these evenly on the world market, and if they’re not tradeable options then most people would be silly to take the latter. Even in finance, higher variance is at least supposed to imply lower prices / higher yield, though Eric Falkenstein says this is a myth.
You can’ t even trade these evenly on the world market, and if they’re not tradeable options then most people would be silly to take the latter.
And when they do become tradable, must people suddenly then change their preferences? (The arbitrage argument for Independence, I feel, is as weak and as strong as the arbitrage argument for a utility linear in money)
Now if I wanted to do that exact bet, a bank would put it together for me—with a hefty premium because it’s an unusual one (maybe UK bookies would give me a better bet). This exact option is only rare because people don’t want to admit that playing the stock market is similar to playing the lottery. If I transformed the bet into something similar, except phrased in terms of hedged commodities future, then you would easily be able buy and sell it, and its price would be around ¥10 000.
For it is easy to show that if those 50% lottery were generally traded, they would have to cost ¥10 000. First, take the lottery as above, along with a similar lottery that pays out ¥20 000 only if the first lottery pays nothing.
Together, these two lotteries are worth a certain ¥20 000. Yet the two lotteries are identical individually, so the Law of one price implies they have the same price—which must then be ¥10 000.
Charging higher prices for low variance is one of the ways banks pump money from the suckers.
Indeed. Ultimately, we might prefer high or low variance, but on proper financial markets, the cost of increasing or decreasing variance is negligeable.
Not so. Buying assets in order to hedge risks is one of the fundamental functions of modern finance market, and the motivation for essentially all “interesting” financial instruments (futures, options, CDSs, etc). Note that the prices of options are even talked about as “implied (Black-Scholes) volatility”, and in trader jargon buying or writing options can be referred to as “trading volatility”. Variance is what modern finance is all about.
You can’ t even trade these evenly on the world market, and if they’re not tradeable options then most people would be silly to take the latter. Even in finance, higher variance is at least supposed to imply lower prices / higher yield, though Eric Falkenstein says this is a myth.
And when they do become tradable, must people suddenly then change their preferences? (The arbitrage argument for Independence, I feel, is as weak and as strong as the arbitrage argument for a utility linear in money)
Now if I wanted to do that exact bet, a bank would put it together for me—with a hefty premium because it’s an unusual one (maybe UK bookies would give me a better bet). This exact option is only rare because people don’t want to admit that playing the stock market is similar to playing the lottery. If I transformed the bet into something similar, except phrased in terms of hedged commodities future, then you would easily be able buy and sell it, and its price would be around ¥10 000.
For it is easy to show that if those 50% lottery were generally traded, they would have to cost ¥10 000. First, take the lottery as above, along with a similar lottery that pays out ¥20 000 only if the first lottery pays nothing.
Together, these two lotteries are worth a certain ¥20 000. Yet the two lotteries are identical individually, so the Law of one price implies they have the same price—which must then be ¥10 000.
Charging higher prices for low variance is one of the ways banks pump money from the suckers.
And casinos charge for high variance.
Indeed. Ultimately, we might prefer high or low variance, but on proper financial markets, the cost of increasing or decreasing variance is negligeable.
Not so. Buying assets in order to hedge risks is one of the fundamental functions of modern finance market, and the motivation for essentially all “interesting” financial instruments (futures, options, CDSs, etc). Note that the prices of options are even talked about as “implied (Black-Scholes) volatility”, and in trader jargon buying or writing options can be referred to as “trading volatility”. Variance is what modern finance is all about.