Monday, December 15, 2008

Dogbert On Modern Financial Theory

Dogbert explains Modern finance theory with regard to diversification:


Arguably, Dilbert creator Scott Adams is slightly unfair here as you're not supposed to invest in things which are almost certain to be worthless, like sick cows, but only slightly so. Clearly there is an over-belief in the value of diversification in terms of reducing risk. While that may usually be the case, it is often not so. For example, risk was not reduced for Swiss banks who decided to diversify away from the calm Swiss real eastate market, and instead invest in American mortgage backed securities. Similarly, someone who owns stock in stable companies like Coca Cola and McDonald's and instead diversified into stocks like Fannie Mae, AIG and GM didn't see risk reduced either.

7 Comments:

Blogger Wille said...

I think Dilbert might be taking a stab at how Mortgage Backed Securities where parcelled up in "tranches", rather than diversification itself.

Considering how different tranches where basically batches of "sick cows", I think the cartoon is pretty accurate.

2:17 PM  
Blogger stefankarlsson said...

Well, that may have been the primary target, but it could also have the wider meaning I discussed.

4:38 PM  
Anonymous Stuart said...

I take away the principle point that it illustrates the deliberate and purposeful deceit and fraudulent understating or risk by those selling such products. Knowing full well they are selling weeds packaged as roses, deliberately understating the risk in order land the sale. The investor here is perhaps too passive as well. Hmmm, application to Bernard Madoff investors too perhaps, maybe.

3:48 PM  
Anonymous Anders said...

I believe that is the point too but a somewhat inaccurate point since I believe that it was neither particularly deliberate nor purposeful. I believe that they had no idea how risky these assets where. This due to the fact that although it was their job to know the risk involved that is not what they actually got paid for. It was possibly premeditated ignorance but more likely just ignorance.

5:20 PM  
Anonymous Amir said...

Stefan Karlsson:
I love your blog. Is it true that silver will outperform gold in the coming 2009? Another question, is it a good idea to go short on the Dow right now?

6:49 PM  
Blogger stefankarlsson said...

Stuart & Anders: the point of the Dilbert cartoon was that it is not true that risk will necessarily go away just because you invest in more things. Whether that assertion is based on an intention to scam others or cluelessnes is not really relevant.

Amir, you're supposed to ask such questions in the Q&A section, but since I assume you're new I'll let it pass.

I haven't studied the supply/demand
trends for silver enough to give any definite assessment on whether it will outperform gold or not. But I can say that demand for silver is more linked to industrial uses, and less linked to monetary applications (though gold does have a limited industrial use, and silver some monetary demand), meaning that it will be hurt relative to gold in the event of renewed stagflation.

As for shorting the Dow, that could soon be a good idea. Right now the Fed is flooding the markets with money causing all assets, even stocks, to go up. However, with the underlying economy and therefore also corporate profits being so extremely weak, another sell-off is likely after the current bear market rally has run its course. However, with bond yields being so incredibly low (Just 2.25% for the 10-year note!), the downside potential for stocks looks more limited than before.

9:02 AM  
Anonymous Amir said...

Stefan Karlsson:

Thanks for the insight. Looking forward for more input from your blog.

2:00 PM  

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