In the fantasy world of academic finance, in which (among other curious assumptions) all knowable information is posited to already be factored into the current price of every stock, risk–the chance of making or losing money–boils down to volatility.

The main virtue of this assumption is its simplicity. …no need to analyze company financial disclosures, study competitors, read government economic research, listen to trade associations, visit the stores, use the products, sit at a trading desk or put money at risk by actually buying or selling stocks.

There is some intuitive sense to the idea. Take a hypothetical stock that trades all the time at $10 a share. Compare that with one that trades at one of $10, $9, or $11, and where trading in the aggregate averages out at $10. The second is riskier in the sense that your trade might end up being a sale at $9 rather than at the for-sure $10 you’d get in the first stock.

Suppose, though, that the second stock is one that is guaranteed to go up by $.10 each trading day. It’s certainly more volatile than the first but it’s hard to say it’s an inferior investment to the dead-in-the-water one.

more tomorrow