Risk: Definition and Measures
For a concept tas central to investing and corporate finance as risk is, it is astonishing how much divergence there is across even finance experts and academics on what it is, and consequently on how to measure it. I have heard some describe risk as uncertainty, essentially substituting one fuzzy word for another, others as the threat of grevious loss and still and still others as the possibility of negative outcomes. If you have taken a finance class, and I confess to having a part in this, you may define risk as volatility or standard deviation, or even bring Greek alphabets into play. My favorite definition of risk and one that I start my corporate finance class with is that Chinese symbol for crisis or big risk (and I am sure that I have mangled the symbols, since I have been corrected a dozen times in the past):
As someone who can neither read nor speak Chinese, I am reliant on friends who know the language, and I have been told that the first of the two symbols is the one for danger and the second is a symbol for opportunity. In effect, by bunding together danger and opportunity, the risk measure captures how risk both attracts (to get to opportunity) and repels (with the threat of danger). That duality explains why an investment or business strategy generally cannot be built around the objective of just minimizing risk, since that effectively will remove access to opportunities or recklessly chasing after opportunities, ignoring dangers
With that definition of risk in place, I will start the discussion of risk measures by examining the choices that we face in making the measurement:
- Upside versus Downside: If you start with a generic definition of risk as receiving an outcome that is different from what your expectation, it is worth recognizing that some of these outcomes will be positive (better than expected) and some will be negative (worse than expected), and that it is the latter than investors and businesses dislike. Thus, there are some who argue that risk measures should focus on just downside outcomes, not all unexpected outcome.
- Price-based versus accounting-based: Risk measures that are based upon data can be built on market prices, for publicly traded firms, or on accounting data, especially earnings. Price-based measures have the advantage of constant updating, giving you more data, but are sometimes contaminated by the noise and volatility that come from trading. Accounting measures yield more stability, but since they are updated infrequently, and accounting smooths changes over time, they can offer stale or distorted values.
- Total versus Non-diversifiable: The risk in an investment, whether a project or a business, can come from many different sources, but some of the risks are more investment-specific whereas others are market-wide:
To the question of why we should care, the presence of many investments in a portfolio implies that risks that are investment-specific will average out, decreasing or even disappearing as portfolios get larger, whereas market risks remain intact. This insight, which earned Harry Markowitz a Nobel prize, gave birth to modern portfolio theory and is at the heart of most risk and return models in finance.
I have my preferences on how best to measure risk, I would like to keep an open mind and start by laying out the choices we face on risk-measures:
As you can see, the risk measure you choose will be a function of whether you (as an investor or business) believe that the marginal investors, i.e., the investors who own the most shares in your business and trade those share, are diversified or not, and what you believe about financial markets and accounting data.
Risk across Companies in 2025
My sample includes 48,156 publicly traded firms and given that these companies trade across different geographies and are in different businesses, it should come as no surprise that there are wide variations in risk across these companies. In this section, I will start with accounting-based measures, with the caveat that accounting standards vary across the world, though IFRS and GAAP have created significant convergence.
Accounting Measures
While there are a variety of accounting metrics that you can use to measure risk, the most logical one to focus on is earnings, but you have many choices. You could use net income or earnings per share, which will reflect not only the riskiness of the business operate in, but also the amount of debt you have chosen to take on, or you can used operating income, more reflective of just market risk. Within each of these metrics, you can measure risk as volatility (in earnings) or in more simplistic terms, on whether you have positive or negative income. For those investors and businesses to whom, it is debt that is the risk trigger, you can look at measures of that debt burden:
Let’s start with volatility in earnings, where we have two estimation choices that we must make, before we get started. The first is history, and I compute the standard deviations in operating and net income using ten years of earnings data, for each firm, a compromise between a number too high (where I lose too many firms in my sample) and too low (where I lack enough data). The second is that earnings standard deviations in earnings will reflect the level of earnings, with higher earnings companies having higher standard deviations. To control for this, I divide the standard deviation of earnings by the average earnings over the ten years, yielding coefficients of variation in earnings. The following table summarizes the distributional values for this metric, across sectors:
It should come as no surprise that utilities have the least volatile operating earnings and have the lowest coefficient of variation on that metric, and that energy and technology haver the most volatile operating income. On a net income basis, financials and utilities have the lowest volatility in earnings, , and energy and communication services have the highest net income volatility.
If you use the frequency of loss-making, as a risk proxy, the table below captures differences on that metric across sectors on this dimension:
Utilities are again the least risky sector, with a lower percentage of money losers than any other sector, and health care and technology firms have a higher percent of money losers than other sectors.
While there are some who use debt loads as proxies for company risk, and we will come back and look at differences across sectors and industries in a later post, it is a narrow measure, since a young, risky, high growth company with no debt would be classified as low-risk, if it is not debt-laden.
Price-based Measures
All of the stocks in our sample are publicly traded, and consequently, you can use market prices to measure risk. That said, liquidity is a wild card, high in some markets and low in others, and that can cause distortions in the comparison.
1. High and Low Prices: One of the simplest measures of price volatility is the range of prices, with wider divergences between high and low prices at more risky companies and smaller ones at safer companies:
HiLo Risk Measure = (High Price – Low Price)/ (High Price + Low Price)
I computed this statistic for each company in my sample, and then the averages across companies in each industry, and it should be lower (higher) for safer (riskier) stocks. Using my global data, this is what this statistic looks like, across sectors:
Utilities again come in as safest, using this risk metric, tied with real estate, and health care has the widest price ranges of the companies in my sample.
2. Standard deviation in price changes: This is a standard statistical construct, and measures volatility in a stock, though it does not distinguish between upside and downside volatility. Based upon the company-specific standard deviations, again averaged out across sectors, here is what the numbers looked like in 2025:
3. Betas: If you buy into the notion that the investors setting prices are diversified, and thus care only about risk that cannot be diversified away, you will focus only on the portion of the standard deviation in a stock that comes from the market, and betas, notwithstanding the misinterpretations and misreading, are trying to measure that non-diversifiable portion of standard deviation and scale around one. Again, looking across industries, I look at the distribution of betas, by sector:
As you review the sector rankings using the varied risk measures, you can see why the heated debates about which risk measure to use is often overdone, since they, for the most part, rank the sectors similarly, with the sectors having less earnings volatility and fewer money-losers also having less volatility in stock price, smaller price ranges and lower betas.
Hurdle Rates
Even as we wrestle with choosing between price and accounting-based measures, it is worth remembering that the end game here is not the risk measure itself, and that risk measures are a means to an end, which is estimating hurdle rates. Hurdle rates come into play for both businesses and investors, setting thresholds that they can use to determine whether to invest or not:
There are some investors and businesses who believe that hurdle rates come from their guts, numbers that reflect personal risk aversion and past experiences, but hurdle rates are opportunity costs, reflecting returns that investors (businesses) can earn in the market on investments of equivalent risk.
In the context of a business, which raises money from debt and equity, you can look at hurdle rates through the eyes of the capital providers – a cost of equity, capturing what equity investor believers expect to make on other equity investments of equivalent risk, and a cost of debt, looking at what lenders can earn on lending to others with similar default risk:
That is what all risk and return models try to do, albeit with different degrees of fidelity to the principle. In fact, my use of an implied equity risk premium in the estimation of the cost of equity is designed to advance this cause, since it is model-agnostic and reflects what investors are pricing stocks to earn, on an annual basis. Thus, when you use the beta in the capital asset pricing model to derive the cost of equity, you should be computing the return you can earn elsewhere in the market on other investments with the same beta, making the cost of equity the hurdle rate for equity investments in a project or company. The cost of capital, which incorporate the cost of borrowing into its construct, is also a hurdle rate, albeit to both debt and equity providers:
As to the question of which of these hurdle rates you should use as a business, the answer lies in consistence. If you are looking at equity returns (return on equity or an internal rate of return based on equity cash flows alone), you should be measuring up against just the cost of equity. Alternatively, with returns on invested capital or an internal rate of return based upon cashflows to the business (pre-debt), it is the cost of capital that comes into play.
I compute the costs of equity and capital for all 48,156 firms in my sample, and in doing so, and in the interests of consistency and ease, I make some simplifying assumptions:
Once I have the costs of equity and capital for each firm, I compute industry averages, both for global firms, and by region (US, Japan, Europe, Emerging Markets, with India and China as sub-categories). You can find the links to the data at the end of this post, but there is another perspective that you can bring to the cost of capital discussion, based upon where a company falls in the company life cycle:
Intuitively, you would expect more uncertainty about business prospects with younger firms, than older ones, especially on the estimation front. That said, it is an open question of whether this uncertainty will translate into higher costs of equity and capital, since it depends on who the marginal investors in these firms are, and whether the risk is diversifiable (and not affect cost of equity) or non-diversifiable. To answer these questions, I classify firms into ten deciles, based on their corporate age, and compute costs of capital:
As you can see, there is no discernible pattern on costs of equity, as you go across the age classes. However, as firms age, they do borrow more, partly because their capacity to generate earnings increase, and that does have some impact on the cost of capital, especially with the oldest firms in the market.
In corporate finance and valuation, an undervalued skill is having perspective, a sense of what comprises typical, and what is a high or a low value. It is for that reason that I also compute a histogram of costs of capital of all publicly traded firms at the start of 2026:
This table is one on my most-used, for many reasons. First, when doing my own valuations, especially for young firms or for firms where the cost of capital is in flux, it gives me the input to us. Thus, if I am valuing a small, AI firm that has just gone public and has global operations, in US dollars, I will start the valuation with a cost of capital of 11.66% and move that cost of capital over time towards 8.65%, as its gets larger and more established. Second, I do see (and must review or grade) other people’s valuations more than I do my own, and this table operates as a plausibility check; a valuation of a publicly traded US company that has a dollar cost of capital of 14% goes on my suspect list, since that is well above the 90th percentile for US firms. Third, the table operates as a reminder that any analysts where the bulk of the time is spent estimating and finessing the cost of capital is time ill-spent, since the 80% of all US (global) companies have costs of capital between 5.26% (6.28%) and 9.88% (11.66%).
For those working in different currencies, the inflation differential approach that I described and used in the last post can be used to convert the entire table. Thus, if you use the expected inflation rates of 2.24% and 4.00% for the United States and India, from the IMF forecasts, you can 1.76% to each of the numbers to each dollar cost of capital that you see in the table or as an industry average.Conclusion
To run a business or invest in one, you need hurdle rates, and that is what costs of equi6y and debt measure. While models and equations may be how you get these numbers, it is always worth going back to first principles, whenever you face questions on what to do. Thus, recognizing that the cost of capital is an opportunity cost, i.e., the rate of return you can earn elsewhere in the market, on investments of equivalent risk, should be a prompt to use betas that reflect the risk in investments, rather than the entities making the investment, and updated costs of borrowing for the cost of debt. As we enter 2026, we are now in our fourth year with US dollar riskfree rates around 4%, and companies and investors seem to have become acclimatized to the resulting costs of capital, and the shock of seeing dollar riskfree rates surge in 2022, pushing up costs of capital across the board seem to have faded.
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Datasets
- Earnings variability, by industry (Global in 2025)
- Money making and losing percentages, by industry (Global in 2025)
- Pricing risk measures, by industry (Global in 2025)
- Betas by industry group (US, Global, Japan, Europe, Emerging Markets, India & China)
- Cost of capital by industry group (US, Global, Japan, Europe, Emerging Markets, India & China)
Data Update Posts for 2026
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