Risk

I was reading a paper "The Equity Premium: It's still a Puzzle" yesterday. The puzzle is that over last 100 years the real return of stocks in the U.S. is about 6% higher than that of T-bills, and economists still can not figure out why people are not investing more in stocks. Qualitatively it's easy to say why the return on equity is higher that that of risk-free T-bills, but quantitatively it does not make sense: stocks are not that risky to justify for a 6% spread. One possible reason is that people are more risk averse than economists have thought.

Here is my quirky way of looking at the curse of risk aversion, from an individual's point of view. If one looks at the society at large, a risk-taking entrepreneurial system will do better than a more conservative one, as advocated by these three economists.

But our brain is notoriously bad at assessing risks in modern world: our stone-age brain overreacts to immediate minor risks, but downplays the remote major risks. We tend to take anecdotal evidences as systematic ones, personal observations as universal norm. The security expert Bruce Schneier has an eloquent piece on this.

What's the take-home messages then? I see two here: first of all every educated citizen should take at least one or two courses in statistics: let the data speak for ourselves when it comes to risk assessing; Furthermore, we all should take more risks, not the blind risks, but the calculated risks with good data behind them, that will make the individuals and the society as a whole better off.