"(This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy)"
You are using an out of date browser. It may not display this or other websites correctly.
You should upgrade or use an alternative browser.
You should upgrade or use an alternative browser.
Is Warren Buffett blind to tail risks/risks of ruin?
- Thread starter Daal
- Start date
It's not just about the probability of winning (or odds in this case), but the payoff that one should care about. So 99:1 that I'll win a penny or lose $1,000,000 is a terrible proposition. 99:1 I'll win $1 or lose $2 is a much better bet. Payoff = probability*(reward/risk).While future probabilities are undoubtedly uncertain, there are all sorts of interesting thought experiments one can perform.
In this particular case, the relevant question is something like this:
"Suppose you are presented with a 99:1 bet. What percentage of your net worth should you bet?"
Sure, I was assuming, very broadly, that the rest of the parameters are given by the context of the discussion...It's not just about the probability of winning (or odds in this case), but the payoff that one should care about. So 99:1 that I'll win a penny or lose $1,000,000 is a terrible proposition. 99:1 I'll win $1 or lose $2 is a much better bet. Payoff = probability*(reward/risk).
Nevertheless still not all his money just a part of it ..."(This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy)"
Back in 2008, Buffett said he was buying US stocks with his non-Berkshire money, with up to 100% of networth
http://www.nytimes.com/2008/10/17/opinion/17buffett.html
"So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worthwill soon be 100 percent in United States equities."
If you are really rich, it makes all the sense in the world to have some money stashed away just in case there is some kind of black swan/tail event and you lose it all (or most of it).
That's what I think he was doing by having some US bonds outside Berkshire.
What is not consistent with that is to have evidence that the black swan is showing up (2008 crisis), then take the money that you had stashed away (that would guarantee you would be wealthy no matter what happened) then put it in something highly correlated to what your main assets are in. Essentially, Buffett shorted even more puts on the 'America always comes back' thesis , and he put even his safe cash in there. It gets worse when you consider that Berkishire is leveraged 1.2-1 or more. He is basically saying that the utility of money doesn't matter to him, risk of ruin doesn't matter to him, all that he cares about are benefits (better valuations/higher expected returns)
But as Taleb shows here, you can add benefits all day long, when risk of ruin/downside risks are involved it doesn't matter how much you add benefits, its the negative side of the tail that matters
This is also confimed by the Kelly formula that shows that you can keep adding benefits (bigger and bigger pay offs) but with uncertain win %'s (that is, with realistic win percentages), the recommended bet amount won't go up that much. At some level it just sorta stagnates. A 6-1 payoff bet with 50% win percetage leads to 41% bet, a 99-1 payoff with the same win pct leads to a 49% bet. Benefits don't change the math much
Is Buffett just tail risk blind?
Not blind
He has spoken of nuclear war and other mankind enders
At the very, very end of the tails things may not matter
The shorts may even theoretically win big, but the investors and traders may all be dead, etc
I dont have that much problem with his puts trades on Berkshire. What I don't understand were the personal risks he was taking, taking his personal account (which I believe was around $100M a few years ago) and doubling down on US equities. Had he been wrong and the US faced a depression, he would face some severe losses from everywhere. When you are so rich, why take the chance? Why not stash away $25M around the globe just in case. Unless he wasn't telling the truth that up to 100% of his non-BRK worth was going to US stocks
What Buffett did was not unreasonable given he was worth roughly 60 billion at the time.
1. He could sell stock or borrow against his stock at a low rate... and regulators are likely to see things "his way" in a close situation.
2. Re Fat Tails: Some (like total destruction of the country by nukes) may not matter as money as we know it may be worthless or everyone may be dead, etc.
3. Re Overbetting: Buffett does not like to bet on edges he would have to see with a microscope and I would bet he understands Kelly, as well as tail risk.
_____
However, I would not be willing to bet every thing I have on all of this ))
_____
Side Note: Dalio handles things by trying to have at least 15 uncorrelated/low correlated bets going and throwing at least 10% gold in the mix. He likes some gold... even if he sees higher edge bets... to insure against some of the tail risks.
Last edited:
That's incorrect because the contracts are/were OTC and setup in a way thatHe sold billions in naked puts on the SPX and rumor was he was days away from a margin call. The trade was held by Goldman and Goldman themselves were days away from being insolvent.
a) premium was paid upfront, about $5 bln. Berkshire was free to invest this as they saw fit.
b) they were only valued at expiration dates, 10 to 20 years into the future (!). There were no daily, quarterly or annual cash settlements.
c) Notional value was around $37 bln. Hardly enough to cause a margin call to a then $200 bln company with an AA/AAA rating.
d) Had Goldman went under then the long puts would have been an asset on their books that would have been up for sale to the highest bidder. There is no mechanism that would have put Berkshire out of business because Goldman went belly up.
That's incorrect because the contracts are/were OTC and setup in a way that
a) premium was paid upfront, about $5 bln. Berkshire was free to invest this as they saw fit.
b) they were only valued at expiration dates, 10 to 20 years into the future (!). There were no daily, quarterly or annual cash settlements.
c) Notional value was around $37 bln. Hardly enough to cause a margin call to a then $200 bln company with an AA/AAA rating.
d) Had Goldman went under then the long puts would have been an asset on their books that would have been up for sale to the highest bidder. There is no mechanism that would have put Berkshire out of business because Goldman went belly up.
You are forgetting that the trade on the books was a liability to GS and at the time they were literally minutes from going under. This trade in particular was not helping their balance sheet. It's not a matter of GS going under, it's a matter of could GS have f*cked Buffet to "prevent" themselves from going under. It's all a moot point now but this trade took GS to the razor's edge in 2008 and was down to their last hours of being a viable entity.
Maverick74,You are forgetting that the trade on the books was a liability to GS and at the time they were literally minutes from going under. This trade in particular was not helping their balance sheet. It's not a matter of GS going under, it's a matter of could GS have f*cked Buffet to "prevent" themselves from going under. It's all a moot point now but this trade took GS to the razor's edge in 2008 and was down to their last hours of being a viable entity.
Do you have a good book/other reference that provides details about that week? I lived through it as a new B-school grad but wasn't in the industry, and at the time there was a lot of incomplete information and I never went back and put together the details afterward. I'd be interested in reading something that wasn't a "bankers are all evil" credo that provided an honest description of the things you described above, if you have any recommendations?
I disagree with this characterisation...You are forgetting that the trade on the books was a liability to GS and at the time they were literally minutes from going under. This trade in particular was not helping their balance sheet. It's not a matter of GS going under, it's a matter of could GS have f*cked Buffet to "prevent" themselves from going under. It's all a moot point now but this trade took GS to the razor's edge in 2008 and was down to their last hours of being a viable entity.
@sle might have more specifics of how these were structured.