It’s nearly a cliche at this point to say that the coronavirus has changed the world. More specifically, it has made us all much more aware of risk and uncertainty. The entire world just discovered that what happens in a wet market halfway around the world can threaten the lives of our loved ones, take away our jobs, destroy our retirement portfolios, and curtail our personal freedoms. In finance, this is known as a tail risk: a catastrophic event we assumed had a low probability of happening or never could have imagined. Once a tail risk occurs, it will never feel improbable again; we become more aware of risk for the rest of our lives.
It is still too soon to tell how the COVID-19 crisis will change our behavior. Will we never look at a crowded room the same way again? Cruises used to be seen as low-risk vacations, predictable and well-planned, but now, their tail risk — being trapped on a boat while exposed to a grave health risk and unmoored for days — feels much more real and may weigh on our minds forever.
We may never approach investing the same way again either. Only a little more than a decade ago, investors got a tough reminder of how volatile stocks can be, having fallen 40% during the financial crisis. It seemed like a once-in-a-lifetime event, but here we are again. In March, Americans saw more than a year of gains wiped out in days. For some, next year’s planned retirement is no longer a possibility. For many of us, this is the second time we’ve experienced such volatility in recent memory.
We all just got a hard lesson in how risky the world can be. But will it change our approach to risk and investing next year — or five, 10, 20 years from now? Odds are, we’ll go back to normal eventually. But how long that takes depends on the virus's impact on us. If our lives are severely disrupted for the next 18 months, or for the rest of our lives, with most people losing a loved one, the risk will weigh more heavily in our minds and change our behavior for longer. But the data, imperfect as they are, suggest we will eventually get past this, and once we do, our short memories will struggle to remember the risks.
Right now, even watching a movie that contains a scene with a crowd provokes anxiety. There is and always has been a risk to large public gatherings, from disease to mass shootings. But we tend to ignore these risks because they are remote and the upside is high: Public gatherings are fun, and we are programmed to seek them out. Humans are social; we like to gather and travel. Zoom gatherings aren’t the same. Lockdowns and economic devastation are not new, arising from both war and disease throughout history, but people again and again prove to be both resilient and forgetful. The parties of the Roaring Twenties followed the Spanish flu and World War I.
If history is any guide, this crisis won’t change how we see risk in the long term. Humans have short memories when it comes to tail risk. Indeed, cruise bookings are already up for next year. The financial crisis was barely more than 10 years ago, but until just a few months ago, it seemed like the stock market could only go up, and many households were eagerly buying up risky assets. The siren call of financial upside makes it easy to forget the downside of bad, unexpected events.
True, markets did recover from the financial crisis fairly quickly. People who stuck with the market ultimately came out ahead. That is not a guarantee this time. If the virus does long, lasting damage to the economy because we can’t allow businesses to restart for many months, many will go under, and we’ll be in for a long, deep recession. In that case, stocks may not recover for a very long time. Children of the Depression never owned as much stock as other generations because the risk of financial markets weighed on them for most of their lifetimes. But odds are markets will recover and our memory of losses will fade.
On the other side of this crisis, we will mostly take the risks we used to, with some notable exceptions. We may always be compulsive hand washers, and some of us may continue to wear masks, facing less social stigma in the United States than before. When we get a sense that a future, similar risk is becoming more probable, extreme risk aversion will probably return. Rather than being slow to embrace social distancing and mask-wearing, we’ll be ready.
Many in the U.S. and Europe were quick to dismiss the novel coronavirus because SARS and H1N1 did not disrupt their lives. It is easy to fault the American and European responses by comparing them to Asian countries that took the risk more seriously sooner. But these countries had experienced major public health risks like this one before and were therefore more prepared for what needed to be done. A stay-at-home order would have struck most Americans as absurd and unnecessary in February. Next time, whenever that may be, Americans are unlikely to see such precautions as nonstarters because the risk will be felt for a generation. We can expect a more compliant population and swifter action because, beneath the surface, we will be more fearful.
There is one way this may be different than past pandemics. In the modern world, we have much better data collection and social media to keep us informed on the latest number of cases and deaths, as well as the projected apex in each city. The risk economist in me takes some pleasure in seeing everyone begin to understand exponential curves and higher-order derivatives while poring over bell-shaped curves to see how sensitive they are to data and assumptions. As the actual apex is reached, earlier or later and, hopefully, lower than expected, people will also learn more about confidence intervals, how data is used to measure risk, and its shortcomings when data are incomplete.
There are downsides to all of this information. MIT economist Andrew Lospeculates that this virus is having more of an impact on the stock market than the Spanish flu did because we are more aware of the risks than people were then. This may be true initially, as we continue to move toward the top of the curve, but in the end, all these data will give us more certainty and alleviate anxiety when we finally start getting good news.
I don’t expect everyone to become a risk economist overnight, but I am hopeful that we will leave this crisis with a better appreciation that risk is an estimate that can give us clarity in an uncertain world. A better understanding of risk measurement, and its shortcomings, helps us process what we’re facing and empowers people to make better decisions. As we live in a world that offers more data than ever, coupled with technology that can deliver risk estimates to us in an instant, perhaps what we learn in these weeks and months will help more people make sense of these tools and make more thoughtful, well-informed decisions about risk in their own lives.
This piece originally appeared at Washington Examiner
Allison Schrager is a senior fellow at the Manhattan Institute, author of An Economist Walks Into a Brothel (Random House), and a co-founder of LifeCycle Finance Partners, LLC, a risk advisory firm. Follow her on Twitter here.
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