What is COEFFICIENT OF VARIATION?
It Measures risk per unit of return.
It helps us choose between two investments where one has both a higher expected return and higher standard deviation than the other.
A simple example to understand the concept :
Investment 1 has an expected return of .40 and a standard deviation of .22.
Investment 2 has an expected return of .23 and a standard deviation of .14.
Which should we choose assuming we are a risk averse investor?
Coefficient of variation is calculated by dividing the standard deviation by the expected return.
Investment 1 : .22/.40 = .55
Investment 2 : .14/.23 = .61
A risk averse investor would choose investment 1 because the risk per unit of return is less.
The vast majority of investors are risk averse, i.e., when choosing between two investments they will choose the less risky of the two.
April 21, 2012 Tutorials