How is Risk Defined in Mathematical Terms?

How is Risk Defined in Mathematical Terms?

Short answer In layman’s terms, risk is the possibility of harm or loss. In finance it refers to the possibility of a monetary loss associated with investments.

Example: The most common measure of risk is simply standard deviation of portfolio returns. The higher this is, the more randomness in a portfolio, and this is seen as a bad thing.

Long answer Financial risk comes in many forms:

• Market risk: The possibility of loss due to movements in the market, either as a whole or specific investments

• Credit risk: The possibility of loss due to default on a financial obligation

• Model risk: The possibility of loss due to errors in mathematical models, often models of derivatives. Since these models contain parameters, such as volatility, we can also speak of parameter risk, volatility risk, etc.

• Operational risk: The possibility of loss due to people, procedures or systems. This includes human error and fraud

• Legal risk: The possibility of loss due to legal action or the meaning of legal contracts

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