Dominant narratives dominate risk
- Markets are supposed to balance risk and reward. The problem is that humans are not very good at seeing risk.
- Humans use storytelling to share ideas. Very often one version of a story will become dominant. It does not matter whether the version of the story is true. If the story is about a really bad event, everyone will know the story. Economists call this a "dominant narrative."
- A dominant narrative may make investors misprice risk. The most dramatic economic event of modern times was the 2008 financial credit crunch. Everyone "knows" that greed, spending, and too much debt led to the crisis. The story tends to add that debt is sinful. (A very similar story exists for the 1920s).
- This story shapes investors' fears today. Investors focus, perhaps too much, on debt levels. Everyone "knows" debt was (in the story) the sinful cause of everything that went wrong in 2008. Thus, debt today must be a risk. But debt today is different from debt ten years ago. There is more government but less private debt. The new risks for investors do not get the attention they should. The story of today's risks is not properly being told.
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6 年Hi Paul,?I’m really interested in this from an awareness distortion perspective. What?I think you’re saying is that a combination of an emotionally charged availability heuristic, loss aversion, unchallenged/non-stress tested beliefs, Groupthink, and fixed patterns of perception, thinking, communication and behaviour are distorting investors understanding of reality, their models of risk and how they price it - which I'm fascinated by, given the industry's singular focus on ROI. To that end then, how accurate/inaccurate is the existing narrative (taking Wolfgang's comments into account), how would you go about falsifying this narrative, and most importantly, what risks should the new, more accurate narrative focus on? Thanks Paul, Rob
Ex-McKinsey Partner, Ex-Investment Banking MD, Book Author, Founder of the "Institute for Future Anticipation and Management" and Founder of the "From Average to Great" Initiative
6 年So, "this time it's different" ... really? Relative debt levels are at extreme levels and keep on rising. GDP growth is mainly a function of debt growth. Central banks are absorbing a great deal of new debt and helping others to do so through ultra-loose monetary policies. This situation deserves to be called a risk. And, we should be prepared to deal with second and third order effects.