Risk aversion

Preferring less uncertainty for the same expected return, and accepting a lower expected return to get it. Its degree differs between investors, and it decides how much risk each chooses to hold.

Where you will meet it

Risk aversion appears in 11 learning outcomes on the CFA syllabus. A few of them:

• Explain risk aversion and what indifference curves show
  CFA Level I · Portfolio Management

  “Risk aversion means that for a given expected return an investor prefers less uncertainty, and will accept a lower expected return to obtain it.”

• Explain why an economic factor can move market values only by acting on at least one of three channels: default-free rates at each maturity, how large and how soon expected cash flows are, and risk premiums
  CFA Level II · Portfolio Construction

  “A surprise rise in unemployment may cut expected profits, lower policy rates and raise risk aversion at once.”

• Explain the factors that feed into choosing a trading strategy
  CFA Level III · Portfolio Management Pathway

  “The manager's risk aversion, together with the urgency implied by how fast the trade's alpha decays.”

• Explain how mean–variance optimisation is used to set an asset allocation and assess its strengths and weaknesses
  CFA Level III · Asset Allocation

  “Mean–variance optimisation uses expected returns, volatilities and correlations to trace the efficient frontier, then selects the portfolio that maximises utility, often written Um = E(Rm) − 0.005 × λ × σm² with returns in percent and λ the risk aversion coefficient.”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with R · Glossary