ERM Glossary: Risk adjusted return
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The risk adjusted return is the expected return on an
exposure adjusted to allow for the premium (or discount) that the market or the
enterprise itself requires in recompense for holding the risk in question.
For example, the premium involved might be derived from the
additional capital a firm may have to hold to keep its overall risk level
constant, multiplied by the additional cost of issuing equity capital to fund
Most texts seem to assume that it is axiomatic that
additional risk requires an increased risk adjusted return. However, this is
not always the case, particularly for market consistent computations involving
sets of contingencies that would provide effective hedges for some market
participants, as explained in Kemp (2009).
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