Variance and beta as perceived risk: questionable science

Abstract

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.

Citation

Olsen, R.A. (2009), "Variance and beta as perceived risk: questionable science", Qualitative Research in Financial Markets, Vol. 1 No. 2, pp. 97-105. https://doi.org/10.1108/17554170910975919