Measures of Risk

Measures of Risk

In Portfolio Management, risk measures are essential tools that help investors to evaluate the potential risks associated with their investment decisions. There are several risk measures used in portfolio management, but two of the most important ones are Standard Deviation and Beta.

Standard Deviation is a statistical measure that indicates how much the returns of an investment vary from its average returns. A higher standard deviation implies greater volatility, which indicates that an investment has a higher level of risk. Standard deviation is often used to compare the risk associated with different investments in a portfolio. Investors can use this measure to determine how much risk they are willing to take for a given level of expected returns.

Beta, on the other hand, measures the sensitivity of an investment’s returns to changes in the market. A beta of 1 indicates that the investment moves in line with the market, while a beta greater than 1 suggests that the investment is more volatile than the market. Conversely, a beta less than 1 implies that the investment is less volatile than the market. Beta is used to measure systematic risk, which is the risk that arises due to factors beyond the control of an investor, such as changes in the economy or political instability. Investors can use beta to determine how much systematic risk they are exposed to in their portfolio and adjust their investments accordingly.

Risk is assumed to be measurable by the variability around the expected value of the probability distribution of returns. The most accepted measures of this variability are the variance and standard deviation.

Central Tendency

The term “measures of central tendency” refers to the various methods used to describe where large groups of data are centered in a population or a sample. Here it is stated another way: if one value or observation is pulled from a population or sample, what would be typically expected for the value to be? Various methods are used to calculate central tendency. The most frequently used is the arithmetic mean, or the sum of observations divided by the number of observations.

 

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