Risk Measurement

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Risk Measurement: 

In addition to considering profit margins, the risk that an investment can create can be measured quantitatively through statistics. 

The most common statistical measure used to describe investment risk is its standard deviation.

Standard Deviation:

From a statistics standpoint, the standard deviation of a dataset is a measure of the magnitude of deviations between the values of the observations contained in the data set.
 From a financial standpoint, the standard deviation can help investors quantify how risky an investment is and determine their minimum required return on the investment.

The most common statistical indicator of an asset’s risk is the standard deviation, σ, which measures the dispersion around the expected value. The expected value of a return, k , is the most likely return on an asset. It is calculated as follows:

                  Standard Deviation=n−1∑i=1n​(xi​−x)2​

where:
xi​=Value of the ith point in the data set
x=The mean value of the data set
n=The number of data points in the data set

EXAMPLE:

The expected values of returns for Norman Company’s assets A and B are presented in Table. Column 1 gives the Prj ’s and column 2 gives the kj ’s. In each case n equals 3. The expected value for each asset’s return is 15%.

In general, the higher the standard deviation, the greater the risk.

Table presents the standard deviations for Norman Company’s assets A and B, based on the earlier data. The standard deviation for asset A is 1.41%, and the standard deviation for asset B is 5.66%. The higher risk of asset B is clearly reflected in its higher standard deviation.







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