What is risk appetite – TroubleinthepeaceS


Risk Tolerance is a measure to assess the willingness to accept risk of investors. In other words, with the same level of risk, an investor can decide to choose or not to choose a portfolio.

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Risk Tolerance

Define

Risk tolerance in english is Risk Tolerance.Risk tolerance is a measure to assess the willingness to accept risk of investors.

In other words, with the same level of risk, an investor can decide to choose or not to choose a portfolio.

Meaning

– Determining the risk tolerance of each investor is to help investors quantify their investment decisions, instead of emotional decisions.

– Assume that each investor can determine the utility (or satisfaction) of holding a portfolio on the basis of the expected return and risk of this portfolio.

Utility value can be thought of as a means of rating investment portfolios. Portfolios with a more attractive risk-return correlation are those with higher utility values.

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Portfolios with the same level of risk have a higher utility score when the expected return is higher, and vice versa.

How to determine utility value?

Determine the useful value according to the following formula:

U = E(r) – 0.5 x A x σ2 (1)

In there:

U is the useful value

A is the coefficient expressing the investor’s risk tolerance

The coefficient 0.5 is a statistical convention that shows the relationship between the expected return E(R) and the standard deviation σ2.

Comment

In Equation (1), for a risk-free portfolio, i.e. zero variance, its utility will be equal to the expected return. This provides us with a favorable standard by which to evaluate investment portfolios.

Different investors will have a different A-factor, depending on the sentiment and the volume of assets that the investor is holding. However, it is difficult to assess an investor’s risk tolerance.

For example

An investor must choose between portfolios X and Y, where:

Portfolio X has an expected return of 10% and a standard deviation of 20%.

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Portfolio Y invests in Treasury bills with a risk-free rate of return of 5%.

Assuming an investor has a risk tolerance coefficient A = 3, an average risk tolerance, then the utility value of the portfolio is:

U = E(r) – 0.5 x A x σ2= 0.1 x 0.5 x 3 x (0.2)2 = 0.04 = 4% (Reference: Textbook of Investment Analysis securities, National Economics University Publishing House; Risk Tolerance, Investopedia)

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