An Acceptable Level of Risk

Individuals differ in the amount of risk that they are wiling to bear and the reurn that they require as compensation for bearing that risk.


1.  The risk-indifferent investor requires no change in return for a given increase in risk.

2.  The risk-averse investor requires an increase in return for a given risk increase.

3.  The risk-seeking investor gives up some return for more risk.


The majority of investors are risk averse.

The historical data on the risk and return of different investments from all over the work indicate that riskier investments tend to pay higher returns.

This simply reflects the fact that most investors are risk averse, so riskier investments must offer higher returns to attract buyers.



How much additional return is required to convince an investor to purchase a riskier investment?

The answer to that question varies from one person to another depending on the investor's degree of risk aversion.

A very risk-averse investor requires a great deal of compensation to take on additional risk.

Someone who is less risk averse does not require as much compensation to be persuaded to accept risk.