An economist walks into a brothel: how unusual places can enhance our understanding of risk
20 December 2019
When I went to graduate school to study the economics of retirement, the last thing I ever expected was that I’d end up in a brothel. I’ve dedicated my career to studying the fundamentals of risk and financial economics in the context of retirement. And no matter how much I learn, my understanding of risk is never complete. We can always learn more and deepen our understanding of risk and the tools we have to manage it.
And that knowledge has never been more critical. Pension fund managers must deal with two types of unknowns, risk (what can be measured) and uncertainty (what you never saw coming). In the past these could be managed somewhat easily, but now both these problems have become more difficult. Political turmoil has made the world and markets more uncertain. Risk management has also become more challenging because the risk-free asset, bonds, offers a much lower return, which leaves pension managers with limited choices if they hope to meet their obligations: save more, take more risk, or hope bond yields rise again. How can pension fund managers deal with so much risk and uncertainty?
Even in this environment we have the tools to manage these risks. This is why now is a good time to revisit the fundamentals of risk management and look outside our comfort zones to gain a deeper understanding of how we can meet the challenges we face.
We are not communicating risk and the value or risk management well. Beneficiaries don’t understand it, and even industry experts sometimes lose sight of it. So, I decided to do something a little unusual. I travelled the United States to meet interesting risk takers and see how people outside of finance think about and manage risk. It turns out they use the same principles we do in finance. We have more in common with sex workers and horse breeders than you’d think. And often, understanding how they manage risk enables us to see subtitles we don’t often appreciate.
I spent time in Nevada brothels and learned how the market assigns a risk premium to sex work. I went to a big wave surfer risk conference where we discussed how to use insurance and hedging techniques to reduce downside risk, while keeping more upside. And I spoke to military generals on how to plan for uncertainty, the risks we don’t see coming.
Stepping outside our world and recasting the problems we face in a new way, helps us gain insight into the problems we face and can help us manage risk in more uncertain and challenging times.
Allison Schrager is speaking at the PLSA Investment Conference 2020.