Risk aversion and capital allocation to risky assets - Risk and risk aversion

6 important questions on Risk aversion and capital allocation to risky assets - Risk and risk aversion

What is the difference between speculation and gambling?

Economically speaking, a gamble is the assumption of risk for no purpose but enjoyment of the risk itself, whereas speculation is undertaken in spite of the risk involved because one perceives a favorable risk–return trade-off.

What is a fair game?

A risky investment with a risk premium of zero, sometimes called a fair game, amounts to a gamble. A risk-averse investor will reject it.

What are heterogeneous expectations?

What is more likely, however, is that the bet results from differences in the probabilities that Paul and Mary assign to the outcome. Mary assigns it p > .5, whereas Paul’s assess- ment is p < .5. They perceive, subjectively, two different prospects. The ideal way to resolve heterogeneous beliefs is for Paul and Mary to “merge their information,” that is, for each party to verify that he or she possesses all relevant information and processes the information properly
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What is the certainty equivalent rate?

The certainty equivalent rate is the rate that risk-free investments would need to offer to provide the same utility score as the risky portfolio. In other words, it is the rate that, if earned with certainty, would provide a utility score equivalent to that of the port- folio in question.

What is the mean variance criterion?

E (rA) ≥ E (rB)

st dev A ≤ st dev B

What is the indifference curve?

These equally preferred portfolios will lie in the mean–standard deviation plane on a curve called the indifference curve, which connects all portfolio points with the same utility value.

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