Risk

The risk of an asset is related to the potential gap between its actual, real return r and the estimated average return E[r]. It is measured by:
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In our previous example, the risk associated to the asset is:
= 5.3%
Covariance measures the level to which the return of 2 distinct securities varies in the same way.
Consider asset a and asset b, then the covariance of these two securities is given by:
If  Cov(ra,rb) is positive, then it is probable that rb>E[rb] when ra>E[ra]
Now if Cov(ra,rb) is negative, then it is probable that rb<E[rb] when ra>E[ra].

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