How to Handle Risk (and Jumping Frogs)

Last Updated Sep 10, 2008 1:00 PM EDT

frog.JPGHandling risk should be a constant, seamless effort. So says Sean Kelley, a portfolio analyst at Tall Tree Investment Management who spoke at a recent University of Chicago Graduate School of Business seminar.
"First, understand the risks you face. Second, decide which risks you want to accept. Then you have to constantly measure and attribute the performance so that you're taking the risk you intended. Finally, you must constantly recalibrate your portfolio risk exposure," he said.

This may sound like basic common sense, but it is remarkable how many executives fail to follow through and do not keep monitoring the risks they have accepted. Witness financial companies from Bear Stearns, to Lehman, to Wachovia, to Merrill Lynch and Fannie Mae and Freddie Mac that sought more risk from such once profitable endeavors as securitizing mortgages and didn't respond fast enough to big market changes.

Kelley says that kernels of wisdom can be found in Mark Twain's classic short story, "The Celebrated Jumping Frog of Calaveras County." For those who don't remember, the story involves a gambler who wanders California with a prized jumping frog named Daniel Webster. He makes a $40 bet on his frog. But when he's not paying attention, someone slips Daniel Webster a shot of whiskey, making the frog un-jumpable. Risk not protected. Bet lost.

(Angel's Camp jumping frog plaque image by Michael Mattis)