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Standard Deviation - Essay Example
Every rational investor wants to invest money in an investment which will give him more money. But the question arises how can one make choice between a set of investments There are number of theories regarding how an investor view risk and prefers one investment over the other ones.
When the data points are spread apart and the bell-shaped curve is flat, the standard deviation -- and the variation -- is great.
Standard deviation with regard to finance can be defined as "Statistical measure that shows the likelihood of an investment to yield above- or below-average returns over a period of time. For example, if hypothetical XYZ Fund has an average annual total return of 11% and a standard deviation of 6.00, which means XYZ Fund's performance is likely to vary from a low of 5% to a high of 17%. Calculated by the fund, standard deviation is only relative to the asset class being measured." (2)
The standard deviation of investment returns is widely accepted as the best, and perhaps only commonly used indicator of portfolio risk in the investment management business. However, its usefulness is actually quite limited. In fact, relying on it can often produce misleading and inaccurate
conclusions. Although standard deviation does provide some insight, and in many circumstances is in fact meaningful but there are a number of flaws associated with relying on the standard deviation of returns as a risk measure.
The bigger flaw with standard deviation is that it isn't intuitive. ...