Risk-return tradeoff
Published:
The risk-return tradeoff (also called the risk-return spectrum or risk-reward) is the relationship between the amount of return gained on an investment and the amount of risk undertaken in that investment. The more return sought, the more risk that must be undertaken.
This transforms a problem of investment in a multi-objective optimization problem in which we have to balance between the expected returns and the assumable risk.
There are various classes of possible investments, each with their own positions on the overall risk-return spectrum. The general progression is: short-term debt; long-term debt; property; high-yield debt; equity. There is considerable overlap of the ranges for each investment class.
One of the simple and most used measures for the risk-return tradeoff is the Sharpe Ratio.
See also
Material
- http://www.investopedia.com/terms/r/riskreturntradeoff.asp
Papers
- Fama, E. F., & MacBeth, J. D. (1973). Risk, return, and equilibrium: Empirical tests. The journal of political economy, 607-636.
- Ghysels, E., Santa-Clara, P., & Valkanov, R. (2005). There is a risk-return trade-off after all. Journal of Financial Economics, 76(3), 509-548.
- Campbell, John Y., and Luis Viceira. The term structure of the risk-return tradeoff. No. w11119. National Bureau of Economic Research, 2005.
- Lundblad, C. (2007). The risk return tradeoff in the long run: 1836-2003. Journal of Financial Economics, 85(1), 123-150.
- Pástor, Ľ., Sinha, M., & Swaminathan, B. (2008). Estimating the intertemporal risk-return tradeoff using the implied cost of capital. The Journal of Finance, 63(6), 2859-2897.
- Lettau, M., & Ludvigson, S. C. (2001). Measuring and modelling variation in the risk-return trade-off. Handbook of Financial Econometrics 1: 617-690.
- Lanne, M., & Saikkonen, P. (2006). Why is it so difficult to uncover the risk–return tradeoff in stock returns?. Economics Letters, 92(1), 118-125.