speeding ticket, or worse still, getting into an accident.
Webster’sdictionary,infact,definesriskas“exposingtoloss
or damage.” Thus, risk is perceived almost entirely in
negative terms.
In valuation, our definition of risk is both different and
broader.Risk,asweseeit,refersto thelikelihoodthatwe
willreceiveareturnonaninvestmentthatisdifferentfrom
thereturnweexpectedtomake.Thus,riskincludesnotonly
thebadoutcomes,(returnsthatarelowerthanexpected),but
alsogoodoutcomes(returnsthatarehigherthanexpected).In
fact,wecanrefertotheformerasdownsideriskandthelatter
isupsiderisk;butweconsiderbothwhenmeasuringrisk.In
fact,thespiritofourdefinitionofriskinfinanceiscaptured
best by the Chinesesymbol forrisk, which is reproduced
here:
Thefirstsymbolisthesymbolfor“danger,”whilethesecond
isthesymbolfor“opportunity,”makingriskamixofdanger
andopportunity.It illustratesveryclearlythetrade-off that
everyinvestorandbusinesshastomake—betweenthehigher
rewardsthatcomewiththeopportunityandthehigherrisk
that has to be borne as a consequence of the danger.
Muchofthischaptercanbeviewedasanattempttocomeup
withamodelthatbestmeasuresthedangerinanyinvestment
andthenattemptstoconvertthisintotheopportunitythatwe
wouldneedtocompensateforthedanger.Infinancialterms,
weterm thedangerto be “risk”andtheopportunity tobe