REPLAY · The Risk Takers: The Art of Risk Management (ft. Hatem Mustapha, Co-Head of Global Markets at Societe Generale)

[beep] Markets and trading floors are noisy, intense, and, as usual, slightly chaotic.

[beep] Yes, you're right.

This is a good example of risk events in markets, economic data, corporate earnings results, geopolitics, et cetera.

A disappointing jobs report, and suddenly, the whole world's on fire.

Bond yields are plunging, equity markets are crashing, and investors are panicking as they fear a recession will inflict more losses on their investment portfolios.

But sometimes markets do overreact.

[bell rings] Main Street, also known as the real economy, and Wall Street, the world of financial markets, are not always in sync.

Markets reflect the current health of the economy but also anticipate the potential risks in the future.

In other words, they constantly incorporate the probability distribution of any outcomes in the prices of financial assets.

[beep] You mean like the precogs in the film Minority Report who can predict future actions and events before they are committed?

[beep] In a sense, yes.

But unlike precogs, markets often get it wrong.

What's interesting is that asset prices can in turn influence the real world, too.

George Soros called it reflexivity.

An article from investopedia.com defines the theory of reflexivity in economics as a feedback loop in which investors' perceptions affect economic fundamentals, which in turn changes investors' perception.

Irrational exuberance in a bullish market, for example, can boost confidence and push businesses to invest and consumers to spend.

It increases what economists call the marginal propensity to spend.

Similarly, market crashes can jeopardize companies' ability to finance themselves, leading to lower confidence in the future and reduce hiring and investments, a sort of self-fulfilling prophecy.

prophecy.Are you humans seriously okay? Or is this one of those virtual reality games where you all pretend the world's ending?

Siri, it's not a virtual reality, although some days it does feel like it.

[laughs] Markets move based on what might happen, but there's a method to this madness.

Let me explain.