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 this capital.

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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