Investment Series : Risk Free Investment Methodology

For a millennium, mankind attempted to define and measure risk.

From the early days of Pascal and Golton to the modern forerunners in academia, defining and measuring risk has been a relentless pursue. Until we properly define and measure risk, there seems no way to mathematically defeat risk, creating risk free financial markets and economies.

Mathematics opened up a new door for mankind with the invention of probability study. Mankind started using probability studies in real life statistical research in the 1660s, starting with a man called John Graunt. Gruant's methods evolved through many hands into what insurance companies of today still use to calculate insurance premiums. Even though probabilistic study is a useful mathematical tool for defining the probability of the occurrence of several outcomes, it has certain flaws. Flaws rendering it useless in helping the world prevent or predict the Great Depression and the subsequent World Wars and each market crash that followed. Probability has 2 major flaws; Firstly, probability is based on each outcomes being mutually independent and random, resulting in a normal distribution and secondly, probability cannot take into consideration more outcomes than what was taken into consideration! Yes, that's what we all mean by being "taken by surprise" isn't it? Mankind has indeed been "taken by surprise" more times than we are willing to admit.

Because new information and new outcomes cannot be predicted, no studies depending on past results and occurrences are valid in the face of new information. That is why investment reports always states "past results do not guarantee future performance". Uncertainty is the main component of risk. Treasury securities are so "risk free" because it has a high certainty of performance.

However, risk is not only uncertainty of outcome but also the consequence of outcome.