Risk Averse, I Would Select Essay

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The first economy could conceivable be at a strong low point when I need my money -- it has a higher degree of market risk. It is less likely, based on the correlation of price movements within that economy, that the economy will be down significantly. There is also less risk that it will be up significantly, but as a risk averse investor I am only considering the downside risk. Therefore, I would choose the option that has the least amount of downside risk.

The question cuts to the difference between market risk and firm-specific risk, and short-term and long-term risk. In this situation, the two economies have equivalent market risk in the long-run. They do not have equivalent levels of market risk in the short-run, however. In addition, there is a higher degree of firm-specific risk in the first economy because the firms are impacted by each other.

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In the second economy, firm-specific risk is offset by the lack of correlated movement in other firms. This means that short-term risk of the economy in general is lower.

The greater the degree of independence among variables, the lower the risk inherent in a portfolio. Higher interdependence implies stronger internal volatility, and as a risk averse investor, my preference would be to choose a basket of securities that has a lower internal volatility, because I am concerned with the fact that I may need my money at any point. The less risk of strong downward movement in my portfolio, the more preferable that portfolio is….....

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