Risk Neutral

  

Categories: Metrics, Derivatives

See: Hedge Ratio. See: Portfolio Insurance.

Any investment (or any bet in a Vegas casino, for that matter) comes with two components: risk and reward. Reward represents the amount you can make. Risk represents a combination of the chances that you might lose...and the amount you could possibly lose in the process.

A risk-neutral investor ignores all that nasty risk stuff. They only focus on the reward. They might drop their entire wad on Red 23, because, at 36-to-1, it’s got one of the best payouts in the casino. Never mind that it only has a 1-in-38 chance of hitting. That kind of thinking is for losers. So says the risk-neutral better.

The concept of risk neutral is more of an academic contrivance than a Thing that exists in pure form in the wild. Most investors have some aversion to risk, otherwise they wouldn’t last long. But the concept has uses in fields of study like game theory.

Related or Semi-related Video

Finance: What are Systematic and Unsyste...14 Views

00:00

finance a la shmoop what are systemic and unsystematic risk systemic risks are

00:09

just endemic to the market want to invest in the stock market and compound [Plate of vegetable appear]

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return your way into great wealth great but then you'll suffer the normal risk

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of the system that risk specifically is this yeah best of times worst of times

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but up over time the market goes up you just have to embrace the notion that [Man hugging a tree]

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there is systemic risk in that in the short run you can buy an S&P 500 index

00:36

fund here then lose like a third or whatever of your money in not too many

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years but if you don't panic and sell just at the wrong time here right out

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the storm and keep going well then you should be just fine by the time you

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arrive here so that's risk that is always in the system equities rise and [Equity in the ocean]

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fall like the tides or something like that but generally they rise and if you

01:00

want to swim in this bathtub well you get used to the turbulence and have an [Girl swimming against the tide]

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airsick bag handy all right that systemic risk or systemic risk

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what's unsystematic risk well it's bad investors or rather bad investing it's

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panicking and selling your stock just when you should be doubling down its

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buying lousy companies thinking that they're cheap today but not realizing [Woman runs away from smelly girl]

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that they will always be cheap because they're lousy or in a lousy industry or

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run by lousy management it's buying into lousy industries that also look cheap

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but are dying hello paper and pulp is yeah anyone really think that's gonna be [Paper printing]

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around in 20 years all right well it's believing the dreamy hopes and prayers

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of future earnings and trusting that there really will be 5 million [Traffic on the highway]

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driverless cars on the road in 3 years you know good luck with that we'd love

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it to be true but ain't gonna be unsystematic risk is also investing in

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bonds for the long-term taking very little risk when taking little risk is

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the opposite of what you should be doing when you're a young investor so yeah

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systematic and unsystematic risk both exist plentifully and both can bite you [Dog bites portfolio from woman]

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right in the portfolio so you got to know what both are and embrace them

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for what they're worth

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