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An efficient frontier is a graph that plots the expected return on a portfolio of investments on the y-axis and its risk as measured by its standard deviation on the x-axis. The Risk & Return chart is similar in concept to a classic efficient frontier image that maps the average return and standard deviation tradeoffs for any combination of assets. Risk-Return Trade off. Lettau, Martin, and Sydney Ludvigson. Image of expert, investment, investor - 182626118. Individual securities must be evaluated not only on the risk-return trade-off in isolation but also on their contribution to the risk-return tradeoff of the entire portfolio. By Michael Taillard . Stated differently, it is the variability of return form an investment. In the graph below, risk-indifference curves are plotted along with the investment opportunity set of attainable portfolios. According to modern portfolio theory, there’s a trade-off between risk and return. Photo about Presenting Graph of Risk/Return Trade off. "There is a risk-return trade-off after all." The Term Structure of the Risk-Return Trade-Off. February 2005; Financial Analysts Journal 61(4914) DOI: 10.2469/faj.v61.n1.2682. One of the primary ways that the risk-return trade-off is incorporated into a portfolio is through the selection of various asset classes. The trade-off between risk and return is a key element of effective financial decision making. The Term Structure of the Risk-Return Tradeoff John Y. Campbell and Luis M. Viceira1 Recent research in empirical finance has documented that expected excess returns on bonds and stocks, real interest rates, and risk shift over time in predictable ways. Risk may be defined as the likelihood that the actual return from an investment will be less than the forecast return. Financial decisions incur different degree of risk. Journal of Financial Economics 76.3 (2005): 509-548. It demonstrates the risk-and-return trade-off of a portfolio and helps us visualize the efficient portfolios, the global minimum variance portfolio and inefficient portfolios. This includes both decisions by individuals (and financial institutions) to invest in financial assets, such as common stocks, bonds, and other securities, and decisions by a firm’s managers to invest in physical assets, such as new plants and equipment. Where 1 of the curves intersects the efficient frontier at a single point is the portfolio that will yield the best risk-return trade-off for the risk that the investor is willing to accept. "Measuring and modeling variation in the risk-return tradeoff." All other factors being equal, if a particular investment incurs a higher risk of financial loss for prospective investors, those investors must be able to expect a higher return in order to be attracted to the higher risk. An investor’s risk/return trade-off function is based on the standard economic concepts of utility theory and indifference curves, which are illustrated in Figure 5-4. Ghysels, Eric, Pedro Santa-Clara, and Rossen Valkanov. Handbook of Financial Econometrics 1 (2003): 617-690. In the chart below, we can see BlackRock’s long-term equilibrium risk and return assumptions for various types of stocks (equities) and bonds (fixed income).
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