fin5 - Risk Risk Aversion and Investment Decisions Econ 333...

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Econ 333 Spring 08 1 Risk, Risk Aversion and Investment Decisions
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Econ 333 Spring 08 2 Risk, Risk Aversion and Investment Decisions After studying this sequence (next six chapters) you will know: How financial risk is defined and measured. How an investor’s attitude toward or tolerance for risk is conceptualized and measured. The concept of stochastic dominance and other portfolio tools. How investor’s attitudes interact with the subjective uncertainty associated with the available assets to determine an investor’s desired portfolio holdings. How investors deal with risk.
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Econ 333 Spring 08 3 Risk, Risk Aversion and Investment Decisions Individuals demand securities (in exchange of current purchasing power) in their attempt to redistribute income across time and states of nature: Reflection of consumption smoothing and risk-reallocation function central to financial markets. People plan their consumption both for today and the rest of their lives with the aim of maintaining their standard of living even though income may vary through time. In order to consume more in the future, people must consume less today, i.e. substitute inter temporally. The decision of whether to consume today or to save depends on the rate of return to savings relative to time preference, i.e. the price of financial assets.
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