The first noble truth, Gautam Buddha said, is Life is suffering. Trained as a financial economist, I translate this as Risks are inherent in life. But when I teach finance to my students, I point out to them that because Risks can be shared we can mitigate the suffering that uncertainties in life can bring. Sharing is the essence of what a family or community and indeed finance is about.
People have traditionally relied on informal mechanisms to protect themselves against the vicissitudes of nature. These informal mechanisms usually take the form of saving for the rainy day, transfers from family members less affected by adverse outcomes, charitable donations by more fortunate members of society, government relief aid in various forms waiver of debt payments, free electricity, water and food for affected people etc.
At the level of the entire country or a state, relief may come from foreign aid and charity mobilised by relief organisations across the world. Even though such informal risk-sharing mechanisms are important in a civil society, they bring their own uncertainty, are not very reliable and are generally limited to a local area international aid and support arrives only for extremely visible calamities. We should be able to do better than that.
This is what financial markets allow us to do. In the jargon of financial economics, many risks can be diversified. For example, many insurance products such as life insurance, automobile insurance, health insurance exist and are used by millions of people. But Robert Shiller, Nobel laureate in economics, has pointed out that there are many risks we face in life (unemployment risk, for example) against which the level of formal insurance (livelihood insurance) is woefully inadequate.
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