How to react to unknown unknowns

Paris attacks, Russian warplane being shot by Turkey, and to some extent the Swiss central bank’s sudden depeg of CHF earlier this year…All of them were unknown unknowns ex ante. Investors can rarely preempt with actions ex ante – or the cost of doing so is relatively high given the great uncertainty about its timing – it is worthwhile asking whether/how investors should react once the event happens, i.e. actions beyond the simple knee-jet response.

Media likes those events – everyone rushes to report them. Investors, or sellside firms that serve investors, need to think clear what require actions versus letting go (treating it as something that adds short-term volatility but not really affects medium-term return). People hate negative surprise, and some just choose to cut their position/exposure when unknown unknown happens, for the sake of peace of mind. However, this actually creates opportunities for contrarian investors to pick bargains. As for sell-side firms who serve investors, it is important to differentiate themselves from news reporters/media. They should discourage the behavior bias of investors, rather than encouraging it like the media usually does. And there is usually no point of rush to be the first to comment on something – that does not add value to investors. It only adds noise.

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