Risk and Return
Supplementary resources for high school students
Definitions and Basics
Risk-Return Tradeoff, from Investopedia.com
The risk-return tradeoff states that the potential return rises with an increase in risk. Using this principle, individuals associate low levels of uncertainty with low potential returns, and high levels of uncertainty or risk with high potential returns. According to the risk-return tradeoff, invested money can render higher profits only if the investor will accept a higher possibility of losses….
In the News and Examples
A Little History: Primary Sources and References
Harry Markowitz, biography from the Concise Encyclopedia of Economics
In 1990, U.S. economists Harry Markowitz, William F. Sharpe, and Merton H. Miller shared the Nobel Prize for their contributions to financial economics. Their contributions, in fact, were what started financial economics as a separate field of study. In the early fifties Markowitz developed portfolio theory, which looks at how investment returns can be optimized. Economists had long understood the common sense of diversifying a portfolio; the expression “don’t put all your eggs in one basket” has been around for a long time. But Markowitz showed how to measure the risk of various securities and how to combine them in a portfolio to get the maximum return for a given risk….
William Sharpe, biography from the Concise Encyclopedia of Economics
In the sixties Sharpe, taking off from Markowitz’s portfolio theory, developed the Capital Asset Pricing Model (CAPM). One implication of this model was that a single mix of risky assets fits in every investor’s portfolio. Those who want a high return hold a portfolio heavily weighted with the risky asset; those who want a low return hold a portfolio heavily weighted with a riskless asset, such as an insured bank deposit….
Risk, Uncertainty, and Profit, by Frank Knight on Econlib