Why is it that riskier investments should give higher expected returns?
I ask not because I don’t get that the avg person would rather invest on something safe than something unsafe, all else being equal. I get that. I ask because I imagine that investors could bring their total risk down through diversification without harming the expected returns, so big money would prefer the higher expected returns even if they are risky, and in doing that, they’d bring down the extra returns from the riskier investments.
Is it because investments options are so correlated that diversification isn’t enough to bring the risk of a portfolio down to acceptable levels? Or some other reason?
I think the answer is yes. I would say it is a very similar strategy to that of corporate financial management and using financial leverage to improve returns and earnings.
Why is it that riskier investments should give higher expected returns?
I ask not because I don’t get that the avg person would rather invest on something safe than something unsafe, all else being equal. I get that. I ask because I imagine that investors could bring their total risk down through diversification without harming the expected returns, so big money would prefer the higher expected returns even if they are risky, and in doing that, they’d bring down the extra returns from the riskier investments.
Is it because investments options are so correlated that diversification isn’t enough to bring the risk of a portfolio down to acceptable levels? Or some other reason?
Investors can always use leverage to get higher risk and higher returns if they want.
Do they really get higher expected returns from that?
I know they do when the market isn’t efficient (relative to the specific investor), but that doesn’t help me.
I think the answer is yes. I would say it is a very similar strategy to that of corporate financial management and using financial leverage to improve returns and earnings.
US taxes treat corporate debt financing more favorably than corporate equity financing, which may be distorting companies towards higher leverage.