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Introducing Risk: The What and Unusual Where of It
Despite the bright Nevada sun, the room was dark and the air stuffy; an obscure I Love Lucy rerun played on mute. A bell rang and a nondescript, pudgy man entered. Suddenly about a dozen women came running from a maze of long hallways, whooshed past me, and lined up in the foyer. Each woman folded her hands behind her back, stepped forward, and said her name. The man pointed to the second woman on the left, a zaftig platinum blonde wearing a red thong and lace bra. She took his hand and led him to her room.
Welcome to the Moonlite BunnyRanch. A legal brothel is perhaps not where you would expect to find an economist who specializes in retirement finance, but I’m an unusual kind of risk junkie. I hunt risk to understand it better. I don’t seek out adrenaline-charged situations. I’ve never bungee jumped, I don’t ski, and I may be the only New Yorker who is afraid to jaywalk. Rather than look for risky situations for the rush of defying the odds, I search for unusual places that can teach me more about risk and how to manage it.
I was trained to shape policy, advise captains of industry, or write research papers at a university. And yet there I was, sitting on a red velvet sofa in a vinyl-sided house in a remote corner of Nevada because unusual markets like sex work thrive on risk. We can always find better ways to measure and reduce risk, so I go wherever people might be defying the odds. After all, financing retirement when you don’t know if the stock market will soar or crash, or how long you will live, requires mastering risk.
Sex work is a risky business. I went to Nevada to understand how the industry isolates and assigns a price to this risk. Most sex workers and their clients could be arrested or subject to violence. Sex workers who find their customers on the streets are thirteen times more likely to be murdered than the general population. Thirty-five percent of sex-worker homicides are committed by serial killers. Paying for or selling sex carries a stigma: sex workers and their customers face social, professional, and legal repercussions if they are caught. I went to the brothel to understand what it costs to eliminate this risk.
What is Risk?
When people hear the word “risk,” they automatically think of something terrible, the worst-case scenario, like losing their job, their wealth, or their spouse.
But we need to take risks to make our lives better. We must gamble to get what we want, even if it comes with the possibility of loss. If we want a great relationship, we risk heartbreak. If we want to get ahead at work, we have to volunteer for projects that we might fail at. If we avoid risk, our lives won’t move forward. Technically, risk describes everything that might happen—both good and bad—and how probable each of these outcomes is.
Even the history of the word “risk” illustrates our complicated feelings about the concept: it derives from rhizikón, an ancient Greek seafaring term that describes a dangerous hazard. Though its usage evolved slightly over the years, it always described something perilous. But the meaning changed in the sixteenth century, when exploration of the New World began, and people started to think about risk as something controllable—not left to fate. The Middle High German word rysigo means “to dare, to undertake, enterprise, hope for economic success.”
Whether you realize it or not, you take risks large and small, every day, in all parts of your life. The good news is that you don’t have to leave it all up to chance and hope for the best. This book will show you how to mindfully take a risk and minimize the possibility that the worst will happen.
We are often taught to think of decisions in terms of “if I do X, then I’ll get Y,” but in reality any time we make a decision, a range of Ys could happen, from a superior Y to a terrible outcome. Once we recognize this, we can take steps to alter the range of Ys. We can’t guarantee a positive outcome, but when we think about risk more strategically we can increase the odds that things will work out. This is sometimes called taking a calculated risk, but there is a science to risk that helps you understand what is worth trying and how to maximize the chance of success when you do take a risk.
The science of risk I’m referring to comes from financial economics. While you might be imagining men with slicked-back hair and fancy suits trying to make money—or take yours—most of what goes on in financial markets is simply buying and selling risk. Risk in finance is an estimate of everything that might happen to an asset—say, the odds of a stock going up 2 percent or 20 percent, or dropping 60 percent. Once risk is measured it can be bought or sold: people can choose to increase risk or reduce it, according to their preference. Financial economics studies risk in financial markets, but its lessons can be applied to any market or decision we encounter in our lives.
For example, like any risk scholar, I would never take a New York City crosstown bus, because travel time is totally unpredictable: it takes thirty minutes on average to cross the island of Manhattan via bus, but commutes of more than an hour or as short as fifteen minutes are possible, depending on the day or time. If I walk, it takes thirty-five minutes—every time. When I walk, I don’t have to worry about excessive traffic or lots of stops to let people on and off the bus. Walking crosstown is almost perfectly predictable, and for me takes just about as long as riding the bus. To put it in terms of financial economics: if you need to decide between two portfolios with similar returns, choose the one that is less risky.
These lessons from financial economics can be useful whenever we need to make a risky decision, but most of us never learn them. I have a PhD in economics, but I didn’t learn much about finance until I finished graduate school. I had assumed financial economics was simply the study of how people try to beat the stock market to get rich. While that’s part of it, because increasing risk offers the possibility of making more money, financial economics is more than that: it is the study of risk.
As I learned more about financial economics, I started to see how its market-based lessons on risk could translate into a new way to understand and see the wider world. Knowing how to use these tools would empower us to make better complex risky decisions every day, from deciding to go back to school or take a job at a start‑up, to allocating an amount of time to work on a project or determining how much to bid on a dream house.
The economics of risk are everywhere. When writing this book, I did something economists rarely do. Rather than sit at my desk at home and just look at data, I spent many hours in the company of noneconomists, far from Wall Street, and asked them how they manage risk in their lives and careers.
Everyone I interviewed has found clever ways to identify and manage risk in a rapidly changing economy. Their stories illustrate the most important principles of financial economics better than any story about the stock market ever could.
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