Globalist Analysis

The Color of Risk

Is color-coding terrorism risk any more useful than the 1990s color scheme used to denote financial risk?

Is the color-coded terror alert system useful?

Takeaways


The 1990s in the United States was the decade of the stock market. Up to 50% of U.S. households were investing in stocks — and saw the value of their portfolios rise ever higher.

Not that Americans did not worry about risk then. On the contrary, during the 1990s, everybody discussed risk. Even school kids suddenly knew how to define risk.

It was volatility, of course — the more the price of an asset fluctuates, the greater the risk of investing into that asset. You could easily measure risk using elementary statistics — by calculating the standard deviation of price changes over time.

Risk was also associated with reward. The bigger the risk, the greater should be the returns investors demanded from their investment.

Some money management companies even adopted a color code approach to market their mutual funds. This system ranged from very safe funds — such as the ones that invested in proven blue chip stocks — to aggressive growth funds.

Safe funds were coded green, gradually moving toward red as the risk of the fund increased. An investor could then easily find the risk/reward ratio he or she felt comfortable with, merely by looking at the color of the mutual fund in question — or even at an entire portfolio of mutual funds.

When the stock market began to tumble in 2000, those deep red mutual funds were the first to lose their value.

Some of the more aggressive ones — especially those that invested in Internet start-ups which supposedly had huge reward potential — lost over 90% of their value.

Like the "Extra Hot" salsa — which is, incidentally, also color-coded from green to red — those funds proved too hot to touch.

But even relatively safe green-coded funds lost plenty of money fir their investors. Some of the biggest names in U.S. business — including Intel, Microsoft, GE and Disney — lost as much as 50% of their value from their peak.

Few people in the United States care to remember the color code for financial risk. Especially since it has been supplanted more recently by another color scheme — the one that has been adopted by Tom Ridge, the secretary of the newly-created Department of Homeland Security.

Here, too, the risk is measured by moving from less risky green to very risky red. Except it denotes the risk of a terrorist attack. And, unlike financial risk, it has nothing to do with volatility. It merely tabulates intelligence information gathered about the activities of al Qaeda and other terrorist groups and tries to decide how credible warnings of an impending attack really are.

The bear market on Wall Street showed that in financial markets colors really don't mean much. The question is — are Secretary Ridge's attempts to signal risk of a terrorist attack much more useful?

The use of color by the new Department of Homeland Security certainly symbolizes the great difference between the 1990s and the new century.

However, even if there had been such color scheme in use on September 11, 2001, despite some clear warnings that were found in retrospect, the day probably would have been marked by one of those yellow or orange hues.

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