Securities and Exchange Board of India is at a loss: it does not know how to rate shares. It would like the risk of investing in a share to be summed up in a single figure, but has not yet found one. It has now thrown a challenge to mathematicians, accountants, advisors, speculators, and calculators to come up with a number it can attach to every share that would tell the investor how risky it is. It cannot ban pensioners from investing in shares, but it would like to protect them from the risk that tycoons or landlords can afford to take.

One may doubt if such a number exists. Risk is essentially in the future, and if ordinary humans were capable of mastering it, many including palm readers, business forecasters and investment advisers would be out of business. Because the future is unpredictable, an entire industry of people who claim to be its predictors survives.

But SEBI is not looking for a forecast; it is looking for a measure of difficulty of making a forecast. If the future is unpredictable, and a forecast is impossible, how does the forecasting industry survive and prosper? Is it only selling pipe dreams? Investors do not think so; and if investors have faith in the possibility of forecasting, SEBI, their servant and protector, can hardly disown it. But having watched the forecasting industry for a quarter century, it probably has little faith in forecastability. It would like to have a figure to reflect that lack of faith. Self-proclaimed investment experts make hundreds of forecasts day after day; since investors trust them enough to keep them alive and kicking, they cannot be put to sleep. Instead, SEBI would like every forecast to carry a number reflecting how untrustworthy it is.

Experts do not just tell investors to buy this and sell that; they also give reasons, which cover the risk as well. And investors do not have to have advisers; they can work out the risk themselves. How do they do it? The most commonly cited figure is the price-earnings ratio. The more attractive a share, the more people invest in buying it, and the higher its PE ratio. SEBI could publish an index of the mean PE ratio for a group of shares. It could also publish a number of indices for different groups; their spread would give it an idea of risk applicable to them.

SEBI could well say that the PE ratio is an index of investors’ optimism or pessimism, and not of the risk they bear. But there is another solution: the confidence or unanimity with which these expectations are held could be measured by the standard deviation of PE ratios for various shares; the higher the standard deviation, the lower the confidence, and the higher the perceived risk. To standardize standard deviation, it should be divided by the mean to give the cofficient of variation.

However, the coefficient of variation would be influenced by many other factors besides risk. The fortunes of industries or companies would diverge. International trade would affect shares differently depending on companies’ participation in it. Interest rates would also have a varying impact depending on companies’ debt dependence. One way to free share prices from these influences would be to take the coefficient of variation of their rates of change. Every index is a mean of changes in the prices of the underlying shares: it shows the trends in share prices. Its coefficient of variation would be a measure of trends’ uncertainty or fragility. Whether an investor makes money or loses it depends on the trend – on whether share price goes up or not. The uncertainty of the trend is an indicator of the risk attached to it. Hence in my view, the coefficient of variation of the trend is the riskometer that SEBI is looking for.

I calculated coefficients of variation of one-month periods from Sensex for two years; the series fluctuated mostly in a 1:3 range. It shot up to 15:25 for some days once in a while, and then subsided. It was not the riskometer SEBI is looking for; more experimentation is needed.

There would be as many coefficients of variation as there are indices. For each index, one could calculate riskometers for periods of different lengths. For frequently traded shares, this is no problem: the price may change hundreds of times in a day. So for every figure in an index, there can be an accompanying coefficient of variation. Newspapers would baulk at publishing so many coefficients of variation; they would take up too much space. But websites would have no problem of space.

But the riskometer is of more concern to SEBI than to the media; so initially at least, it should take an initiative in calculating and publishing coefficients of variation. At present, SEBI’s website is a most boring one. It has a statistical bulletin, but it gives such old figures that I doubt whether anyone ever looks at it. It should set up a website giving all indices of all stock exchanges, and their coefficients of variation for various periods.

Now that it is getting interested in stock market statistics, SEBI should fund economic research based on them. Ideally, the stock exchanges should fund and publicize the research. But my observation is that stockbrokers have no interest in economics or statistics. So it would be best if SEBI sponsored and published the research. To attract better economists, it should also give prominence to the economists who do the research. It could set up its own economic institute; but it should not be too close to the institute. Intellectual independence is important for economists’ reputation. Reserve Bank and Federal Reserve are good models to follow.

Calculating and watching risk is a good idea; but it is even more important that SEBI should work to reduce risk. That is what derivatives do; and SEBI has been most unfriendly towards them. As a result, Indian derivatives have migrated to Singapore. But Singapore will never have enough of them, because it will not have enough investors in Indian equities. Of course, derivatives carry risk, for markets as much as for investors. But the risk materializes once in a blue moon, whereas the information derivatives give reduces risk, and is available to everyone all the time. SEBI should learn from the regulators of the world’s biggest financial markets; they have permitted a variety of derivatives, despite the fact that the derivatives have caused a meltdown once in a while.

SEBI has been a very conservative regulator: it has reined in stock exchanges in the belief that it was protecting the Indian investor.  But as a result, it has repelled investors who have resources and who like to take risk; those rich enough invest abroad, whilst the rest invest in property. The Indian equity market is small, and is dominated by conservative, semi-official institutions. The result is that the Indian corporate sector has failed to grow and develop the Indian economy. One reason why the Chinese economy has left India far behind is its dynamic corporate sector; our careful and effective SEBI has contributed to our backwardness.