Monday, June 8, 2015

Define Risk Aversion and Risk Premiums?

"Risk aversion" refers to a phenomenon whereby people try to avoid financial risk.  This is manifested by a reluctance to take a high risk opportunity with a potentially high payoff.  Risk averse people will instead opt for a low risk, low reward opportunity.


Because risk aversion exists, businesses that wish to engage in high risk behavior have to pay a "risk premium" in order to attract investors.  Technically, the risk premium is the extra amount of return (over that of a risk-free investment) that the high-risk investment must pay to attract investors.

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