Chapter Eighteen Flashcards
Ex Ante
Determined before the state of the world is known.
State of the world
A potential set of conditions
Ex Post
Determined after the state of the world is known.
Expected Value
The average value over all states of the world, with each state weighted by its probability.
Law of large numbers
When a gamble is repeated many times, the average outcome is the expected value.
Riskiness
Variation in potential outcomes.
Risk Free
Having the same value in any state of the world.
Fair odds
Odds that reflect the true probabilities of various states of the world.
Diversify
To reduce risk
Risk Neutral
Caring only about expected value.
Risk Averse
Always preferring the least risky among baskets with the same expected value.
Risk Preferring
Always preferring the most risky among baskets with the same expected value.
Uninsurable Risk
A risk that cannot be diversified.
Future contract
A contract to deliver a specified good at a specified future date for a specified price.
Futures market
The market for futures contracts.
Spot Market
The market for goods for immediate delivery.
Spot price
Price in the spot market.
Speculator
One who attempts to earn profits in the futures market by predicting future changes in supply or demand.
Returns
Gains to the holder of a financial asset, including dividends and increases in the asset’s value.
Expected return
The expected value of return
Standard Deviation
A precise measure of risk.
Investors
Buyers of risky assets
Portfolios
Combinations of risky assets.
Efficient set
The northwest boundary of the set of all portfolios.
Efficient portfolio
A portfolio in the efficient set.
Capital asset pricing model
A model that assumes that investors care only about expected return and risk, where risk is measured by standard deviation.
Market Line
The line through a risk free asset and tangent to the efficient set.
Market portfolio
The point of tangency between the market line and the efficient set.
Rational Expectations
Expectations that, when held by market participants, lead to behaviour that fulfills those expectations on average.
