Variance and beta as perceived risk: questionable science
Robert A. Olsen
Purpose – The purpose of this paper is to discuss the origin of variance and beta as risk measures and to identify their shortcomings as perceived risk metrics. Design/methodology/approach – The paper analyses seminal literature from economics, psychology, and neuroscience that have relevance to financial risk. Findings – There is empirical evidence that investors are loss-averse and affectively influenced. Variance and beta as conventionally calculated are flawed because they do not take into account the inherent indeterminacy of the investor's world. Practical implications – The paper demonstrates that perceived risk will be systematically mis-measured and that risk premium/return anomalies will prevail until a more affective and multidimensional risk metric is utilized. Originality/value – The value of the paper lies in its concise and clear identification of financial risk measurement issues and a suggested direction for remediation.
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