The concept that every rational
investor, at a given level of
risk, will accept only the largest expected
return. That is, given two
investments at the exact same level of risk, all other things being equal, every rational investor will invest in the one that offers the higher return. The risk-return tradeoff is pervasive throughout
economics and
finance. It is the reason that riskier
bonds pay higher
coupons than other bonds. It is also the reason that bonds pay lower returns than most stocks because they are a less risky investment. The
Markowitz Portfolio Theory attempts to mathematically identify the
portfolio with the highest return at each level of risk. See also:
Markowitz Efficient Portfolio.