I am not an expert in the field. So bear with me if my terminology is bad.
I want to understand what risk premium of a portfolio is. I understand that there are different forms of risk. The basic idea seem to stem from the following basic difference. A portfolio which gives a fixed return of 5%, is considered different to a portfolio which gives a mean of 5% but has variance. Since variance is not "desired", the latter needs a premium return to match the former portfolio.
- Is this understanding correct?
- Is there any mathematical basis in saying that variance is not "desired"? Or is it purely psychological? (based on individual risk aversion, utility functions and so on).
- If the reasoning is purely psychological, should we logically factor in this premium when creating a portfolio?