Monday, August 25, 2008

Gambling, Speculation, and Investment

Mike Moffatt asked How do Investments, Gambles, Speculation, and Insurance Differ?

The only potential difference I can think of between gambling and speculation is that gambling often doesn’t change the odds but speculation always does, if only infinitesimally, by providing information to the market. One could restrict gambling to fixed odds but that would not be common, so I would say this transaction alone, a far out of the money option, is gambling and speculation. If combined with an offsetting position, say a real trade, it can then be insurance and a hedge, the difference is which a hedge can be profitable while insurance can only offset a loss. The differentiating factor between speculation and investing is investing provides an income flow while holding it. This may be restricted to interest and dividends or relaxed to earnings but in their absence is only a speculation. A liquidation value is more or less speculative. Depending on services provided or cash flow, real estate may be an investment or speculation.

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