While risk-reward is integral, the value of the risk is derivative. The value derives from demand and can be manipulated.
Risk can be “put and called” in options markets. It can also be forced into “backwardation or contango” in futures markets, depending on the price, which yields expected demand.
(Back in ’07-’08, inferring the probability from the evidence, it appeared to me that the price of oil was being manipulated. Energy prices were rising in the futures, which pushes prices up for everything else, despite the probability of lower demand. This “value” premium was being produced in OTC markets–the dark markets that, despite ample warning, were unregulated at the behest of Randian Ivy Leaguers like Lawrence Summers and Alan Greenspan. Subsequently, Forbes magazine published an article that describes how Goldman Sachs manipulated oil markets to record prices, which supported a strong recessionary trend–i.e., rising prices against declining demand. The “risk value” this produces is the pawn-shop model: when times are bad you pawn all your stuff and when prices fall to meet demand you buy it back at a loss. The double detriment is the value that derives from the risk.
Remember Blankfein’s testimony before Congress to defend Goldman’s practices. If you were smart, like Goldman, you would have sold short everything you had before the crash. Goldman did that using OTC derivatives, yielding high prices against falling demand in the futures.)
Risk is a discreet quantity (a commodity) manipulated to yield capital on demand.
When supply is up the price is down, when supply is down the price is up. This risk-on/risk-off scenario appears to be categorically inverse but it isn’t because it derives from demand.
Econometrically, demand is empirically measured by the money supply. Just because you are hungry does not mean crops are in demand. You have to have the money–the income–to demand it. Similarly, you can’t pay your mortgage if you don’t have the money. In both cases, supply exceeds demand against rising prices. Eventually, without added liquidity (like borrowing against the rising price of your home), supply meets demand at the empirically verifiable, deflated price.
During the Great Depression, agricultural commodities were destroyed despite growing hunger. During the Great Recession, homes were destroyed despite growing homelessness. In both cases, is the risk on or off? What is the utility?
To determine the status of “the risk,” it is optioned and futured. If you thought the formula for pricing futures was abstruse, have a look at the formula for pricing options, which is essentially an indicator of the probable risk. In both cases, the utility is to support the price against falling demand and in some cases resist the price as demand rises. Risk, then, is not categorical, it is an arbitration. It is an arbitrage argument to derive value from the risk at a premium.