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Hi Tutor,
Scenario:
Coefficient of variation = Standard deviation / Expected value (mean)
Investment X = 15% / 20% = 0.75, or 75%
Investment Y = 20% / 25% = 0.80, or 80%I understand the interpretation of the risk to reward ratio, i.e. the higher the more relative to the deviation = riskier, but what does coefficient of variation actually tell us, for example:
Does it mean there is a 75% chance that the expected value will deviate by 15%?
or
Does it mean that the expected value will most probably deviate by 75% of the 15% (i.e. 11.3%)?
Looking forward for your reply.
Many thanks.
Best regards,
KennyThe best interpretation for you is not really to do with probabilities: it is a matter of scaling and the significance of the variations.
For example, if you had an investment worth on average $1000 with a standard deviation of $5, intuitively you would realise that the value was very stable. It is a low risk investment. You could work out the probabilities (using normal distribution tables) of the value falling below 980 or rising above 1020: gains/losses of 2%. These probabilities would be small.
However, if you had an investment worth $10 on average with a standard deviation of $3, you would realise that this was risky. There is a very good chance that the value could fall to $7 or below or rise to $13 and above.
So, the absolute value of the standard deviation means little. You have to take the mean value into account as well. A High CoV is relatively more risky than a low CoV.
HTH
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