Portfolio Theory
In portfolio choice, a risk neutral investor able to choose any combination of an array of risky assets (various companies' stocks, various companies' bonds, etc.) would invest exclusively in the asset with the highest expected yield, ignoring its risk features relative to those of other assets, and would even sell short the asset with the lowest expected yield as much as is permitted in order to invest the proceeds in the highest expected-yield asset. In contrast, a risk averse investor would diversify among a variety of assets, taking account of their risk features, even though doing so would lower the expected return on the overall portfolio. The risk neutral investor's portfolio would have a higher expected return, but also a greater variance of possible returns.
Read more about this topic: Risk Neutral
Famous quotes containing the word theory:
“By the “mud-sill” theory it is assumed that labor and education are incompatible; and any practical combination of them impossible. According to that theory, a blind horse upon a tread-mill, is a perfect illustration of what a laborer should be—all the better for being blind, that he could not tread out of place, or kick understandingly.... Free labor insists on universal education.”
—Abraham Lincoln (1809–1865)