|analytical Q||May-Aug 2000||Sept-Dec 2000||Contact||Discussion|
I like to relate abstract concepts to real life examples that are easier to understand. Recently I was reading about project finance and portfolio risk assessment. The latter is largely dependent on concentration and correlation.
Someone won a Nobel prize for figuring out not to put all your eggs in one basket. Portfolio diversification is the idea of putting your money in different pockets. The more pockets, the better. Concentration is a measure of diversity - the higher the concentration, the lower the diversity. The lower the concentration - that is - not concentrated on one or two pockets, the higher the diversity. The greater the diversity, the lower the risk.
I'm not sure if anybody has won a prize for correlation yet. Basically, it says that - the pockets you put your money in - should be as unrelated as possible. The less related, the less correlated. If one pocket is made of cotton, another made of wool, etc..... so that if one bursts, another one won't. Correlation varies from negative one to positive one. Zero correlation means completely random - no correlation at all.
I could apply these concepts to the management of my own finances. Don't put everything in my savings account. Hide some under my pillow. Invest some of it in assets, like my grand piano. I have unconsciously applied these concepts to the friends I made over the years. They are spread out (low concentration) and don't necessarily know each other (low correlation). Does this mean that I have a well-diversified (low risk) set of friends? It certainly helps when I want to hear different points of view on a subject.
Due to the seasonal clock change on Sunday 29 October, my own internal clock went beserk. I went on Internet time - ahead of myself. I'm actually writing this diary entry on 31st October 2000. Once again, the door bell rang, and I had to disappoint the kids on Halloween Night. Sorry, no candy.