Fundoo Professor

Investment returns are typically measured in the form of returns per unit of risk.

“Risk” however does not mean the same thing to different people.

To most financial academics, risk is a measure of volatility, a proxy of which is the famous beta. At the other extreme is Warren Buffett who thinks of risk as “probability of permanent loss of capital” and who claims that beta has nothing to do with risk.

While the debate on the meaning of risk between academics/finance practitioners who follow CAPM (a model that equates beta with risk) and value investors who follow Buffett is not going to end anytime soon, I propose that one should also think about measurement of investment returns based on “return per unit of stress.”

For proprietary investors (and maybe for all investors), stress should figure in one’s investment strategy, much more than it does, perhaps, even more than financial…

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