Amaranth: Looking through the wrong end of a telescope

As we learned in Behavioral Economics 101, investors fear losss more than they crave gains. But does that hold true at the extremes, where immeasurably remote chances of great wealth or great disaster lurk?

The question comes up because of the demise of Amaranth, a hedge fund battered by losses of $6 billion or more. You could almost hear the dazed tone of Amaranth founder Nicholas Maounis as he told investors, “Sometimes, even the highly improbable happens.”

Maybe it happens because it is so improbable.

Hedge fund managers can calculate the risks (volatility) they can expect to face 90% of the time. They can even calculate the likely risks for 99% of the time. But that leaves the extreme, unexpected risk.

One can sense the temptation to view such remote risks through the wrong end of a telescope: "Hey, losing most of our multi-billion-dollar fund in a month is near to impossible. Any risk so very, very remote should be ignored."

When it comes to extremely remote but potentially gigantic rewards, we know people turn the telescope around and look through the right end. Why else would anyone buy a lottery ticket, an investment where risk of total loss greatly exceeds 99.9%?

But who cares about the odds when, looking through the telescope, you can virtually see that immense pile of money coming your way?

Speaking of immense piles of money, suppose you're a money manager, the world's worst money manager.

Every day, including Sundays and holidays, your trades lose $1 million.

Know how long it would take you to lose $6 billion?

Over 16 years!