Question

What is risk? Although many risks (e.g., career risk, risk of how many children to have and whether they will succeed morally and academically, etc.) in the real world are not tradable, some risks (e.g., stock price risk, credit risk, interest rate risk, currency exchange rate risk, risks that insurance policies cover, etc.) are actively traded in the market. What determine the equilibrium price of tradable risks?

Answer 1

First of all we will understand the meaning of Market Risk or you can say Tradable risk- Market risk is the possibility of an investor experiencing losses due to factors that affect the overall performance of the financial markets in which he or she is involved. Market risk, also called "systematic risk," cannot be eliminated through diversification, though it can be hedged against in other ways. Sources of market risk include recessions, political turmoil, changes in interest rates, natural disasters and terrorist attacks. Systematic, or market risk tends to influence the entire market at the same time. The most common types of market risks include interest rate risk, equity risk, currency risk and commodity risk.

Main Types of Market Risk

Interest rate risk covers the volatility that may accompany interest rate fluctuations due to fundamental factors, such as central bank announcements related to changes in monetary policy. This risk is most relevant to investments in fixed-income securities, such as bonds.

Equity risk is the risk involved in the changing prices of stock investments, and commodity risk covers the changing prices of commodities such as crude oil and corn.

Currency risk, or exchange-rate risk, arises from the change in the price of one currency in relation to another; investors or firms holding assets in another country are subject to currency risk.

Competitive equilibrium is a condition in which profit-maximizing producers and utility-maximizing consumers in competitive markets with freely determined prices arrive at an equilibrium price. At this equilibrium price, the quantity supplied is equal to the quantity demanded