Section: 1 What is Risk?

Sub Section: 1 Risk Aversion

The foundation of finance and investment is based upon certain assumptions. One of them is the risk aversion of investors: Investors are basically risk averse and will only take additional risk if compensated by additional return. If two securities offer the same return, they will choose the one with less risk. If two securities have the same risk, they will choose the one with higher return. Let’s see how our measure of stand-alone risk, standard deviation, can be used to confirm this assumption.



Stock A

Stock B

Expected Return



Standard Deviation




It is evident from the above example that even though the two stocks offer the same expected returns, but their risk varies. Hence, investors will opt for stock A instead of stock B.