Morningstar Advisor - February/March 2009 - 43

The Participants Roger Ibbotson r Professor of finance at the Yale School of Management and chairman and CIO of Zebra Capital Management, which manages equity long-short hedge funds. r Founded Ibbotson Associates, a wholly owned subsidiary of Morningstar. r Co-writer of the annual Stocks, Bonds, Bills and Inflation (Morningstar, Inc.), the standard reference for information on investment market returns. r His many books include Global Investing: The Professional’s Guide to World Capital Markets, with Gary Brinson (McGraw Hill, 1992). George Cooper r Principal of Alignment Investors, a division of BlueCrest Management, Ltd. r Studied at Durham University. r Worked as a fund manager at Goldman Sachs and as a strategist for Deutsche Bank and JPMorgan. r Author of The Origin of Financial Crises (Vintage Books, 2008). Benoit Mandelbrot r Sterling Professor Emeritus of Mathematical Science at Yale. r Fellow Emeritus at IBM’s Thomas J. Watson Research Center. r Inventor of fractal geometry. r Received the Wolf Prize in Physics, the Japan Prize in Science and Technology, and awards from the U.S. National Academy of Sciences, the IEEE, and numerous universities. r His many books include The (Mis)behavior of Markets (Basic Books, 2004). that provoke sharp, even overwhelming, discontinuities. Then, I found that the same is true for the prices of wheat, stocks, and a multitude of other price series. The standard theory of price variation assumed continuity, but the data were very discontinuous. I became hooked on this problem and have worked on it ever since. By training, I am a mathematician, but a very peculiar one, for an easily identifiable reason. During World War II, I studied by myself, up in the mountains and not in proper school. Therefore, I read many things that nobody else read, and I didn’t learn many things other people learned, consciously or not. So I decided to look more and more carefully at price changes and see whether the fact that anything close to the simplest random walk fails to catch the variability of the process was something particular to the data I dealt with, or more widespread. Kaplan: What you’re saying, Dr. Mandelbrot, is that when you began to look at financial data, you observed that contrary to the standard models, which say that returns follow a bell-curve distribution and move in a continuous fashion, the data were dominated by lurches and discontinuities. Today, of course, there’s a lot of talk about “black swans,” and you’ve coined the term “gray swans” to indicate events that differ significantly from the norm and should be planned for. Mandelbrot: That’s correct. When asked to schools. Nobel Prizes have been awarded for mean-variance analysis, the capital asset pricing model, the Black-Scholes model of options pricing—all of which are based upon this notion that prices move in a continuous fashion. Should Dr. Mandelbrot’s work be taught in business school? Ibbotson: It’s fine to teach it in business school, comment about this, I always say that I’ve been studying gray swans, just because the problem is not just with one specific extreme event. You may say there are swans of every level of blackness, from almost white to completely black, and “completely black” has no limit. Kaplan: Dr. Mandelbrot’s thinking is very but let me say that I don’t think you have to throw out all the standard deviation work because there are jumps and discontinuities in return series. I don’t think there’s any doubt that we have jumps and discontinuities and special events. If you think of the implied volatility in the BlackScholes model, that implied volatility takes on widely different numbers at different times. It’s not a constant, and in fact, where we typically have standard deviations of, say, 20% implied in the stock market, or even 15% different from what is taught in business MorningstarAdvisor.com 43
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Morningstar Advisor - February/March 2009

Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2009

Morningstar Advisor - February/March 2009
Contents
New on MorningstarAdvisor.com
Letter from the Editor
Contributors
Inbox
How Do You Gauge and Measure Risk?
No Skinny-Dippers Here
Heading to Shore
Investment Briefs
Weapons of Mass Destruction?
Déjà Vu All Over Again
A Failure to Gauge Risk
Five Areas to Find Opportunities
Getting a Read on Risk
Heavenly Returns
Greenspring Comes to the Rescue
How to Spot a Trustworthy REIT
Four Picks for the President
Find Succor in These Large Dividends
These Stocks Are Fiscally Fit
Mutual Fund Analyst Picks
50 Most Popular Equity ETFs
Undervalued Stocks
Most Popular Variable Annuities
New at Morningstar
You Gotta Look Sharpe
Morningstar Advisor - February/March 2009 - Intro
Morningstar Advisor - February/March 2009 - Morningstar Advisor - February/March 2009
Morningstar Advisor - February/March 2009 - Cover2
Morningstar Advisor - February/March 2009 - 1
Morningstar Advisor - February/March 2009 - 2
Morningstar Advisor - February/March 2009 - Contents
Morningstar Advisor - February/March 2009 - 4
Morningstar Advisor - February/March 2009 - 5
Morningstar Advisor - February/March 2009 - New on MorningstarAdvisor.com
Morningstar Advisor - February/March 2009 - 7
Morningstar Advisor - February/March 2009 - 8
Morningstar Advisor - February/March 2009 - Letter from the Editor
Morningstar Advisor - February/March 2009 - Contributors
Morningstar Advisor - February/March 2009 - Inbox
Morningstar Advisor - February/March 2009 - How Do You Gauge and Measure Risk?
Morningstar Advisor - February/March 2009 - 13
Morningstar Advisor - February/March 2009 - No Skinny-Dippers Here
Morningstar Advisor - February/March 2009 - 15
Morningstar Advisor - February/March 2009 - 16
Morningstar Advisor - February/March 2009 - Heading to Shore
Morningstar Advisor - February/March 2009 - 18
Morningstar Advisor - February/March 2009 - 19
Morningstar Advisor - February/March 2009 - Investment Briefs
Morningstar Advisor - February/March 2009 - 21
Morningstar Advisor - February/March 2009 - Weapons of Mass Destruction?
Morningstar Advisor - February/March 2009 - 23
Morningstar Advisor - February/March 2009 - 24
Morningstar Advisor - February/March 2009 - 25
Morningstar Advisor - February/March 2009 - 26
Morningstar Advisor - February/March 2009 - 27
Morningstar Advisor - February/March 2009 - Déjà Vu All Over Again
Morningstar Advisor - February/March 2009 - 29
Morningstar Advisor - February/March 2009 - 30
Morningstar Advisor - February/March 2009 - 31
Morningstar Advisor - February/March 2009 - 32
Morningstar Advisor - February/March 2009 - 33
Morningstar Advisor - February/March 2009 - A Failure to Gauge Risk
Morningstar Advisor - February/March 2009 - 35
Morningstar Advisor - February/March 2009 - 36
Morningstar Advisor - February/March 2009 - 37
Morningstar Advisor - February/March 2009 - Five Areas to Find Opportunities
Morningstar Advisor - February/March 2009 - 39
Morningstar Advisor - February/March 2009 - Getting a Read on Risk
Morningstar Advisor - February/March 2009 - 41
Morningstar Advisor - February/March 2009 - 42
Morningstar Advisor - February/March 2009 - 43
Morningstar Advisor - February/March 2009 - 44
Morningstar Advisor - February/March 2009 - 45
Morningstar Advisor - February/March 2009 - 46
Morningstar Advisor - February/March 2009 - 47
Morningstar Advisor - February/March 2009 - Heavenly Returns
Morningstar Advisor - February/March 2009 - 49
Morningstar Advisor - February/March 2009 - 50
Morningstar Advisor - February/March 2009 - 51
Morningstar Advisor - February/March 2009 - Greenspring Comes to the Rescue
Morningstar Advisor - February/March 2009 - 53
Morningstar Advisor - February/March 2009 - 54
Morningstar Advisor - February/March 2009 - 55
Morningstar Advisor - February/March 2009 - How to Spot a Trustworthy REIT
Morningstar Advisor - February/March 2009 - 57
Morningstar Advisor - February/March 2009 - Four Picks for the President
Morningstar Advisor - February/March 2009 - 59
Morningstar Advisor - February/March 2009 - Find Succor in These Large Dividends
Morningstar Advisor - February/March 2009 - 61
Morningstar Advisor - February/March 2009 - These Stocks Are Fiscally Fit
Morningstar Advisor - February/March 2009 - 63
Morningstar Advisor - February/March 2009 - Mutual Fund Analyst Picks
Morningstar Advisor - February/March 2009 - 65
Morningstar Advisor - February/March 2009 - 66
Morningstar Advisor - February/March 2009 - 67
Morningstar Advisor - February/March 2009 - 50 Most Popular Equity ETFs
Morningstar Advisor - February/March 2009 - 69
Morningstar Advisor - February/March 2009 - 70
Morningstar Advisor - February/March 2009 - 71
Morningstar Advisor - February/March 2009 - Undervalued Stocks
Morningstar Advisor - February/March 2009 - 73
Morningstar Advisor - February/March 2009 - 74
Morningstar Advisor - February/March 2009 - 75
Morningstar Advisor - February/March 2009 - Most Popular Variable Annuities
Morningstar Advisor - February/March 2009 - 77
Morningstar Advisor - February/March 2009 - 78
Morningstar Advisor - February/March 2009 - New at Morningstar
Morningstar Advisor - February/March 2009 - You Gotta Look Sharpe
Morningstar Advisor - February/March 2009 - Cover3
Morningstar Advisor - February/March 2009 - Cover4
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