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Mean-Variance Approaches to Risk-Return Relationships in Strategy: Paradox Lost

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  • Timothy W. Ruefli

    (Management Department, CBA 4.202, Graduate School of Business, and IC2 Institute, University of Texas, Austin, Texas 78712)

Abstract

A growing number of articles in the area of strategic management employ a mean-variance approach to risk-return relationships. Some researchers investigating risk-return relationships in this fashion claim to have found negative associations between the levels of return and risk. The analysis reported here demonstrates that the mean-variance approach to return and risk carries with it the consequence that statements about the relationship are inherently unverifiable in the context of the system being examined. This further implies that results obtained by using mean and variance of return are specific to the data and period examined and are not necessarily generalizable. Additionally, since mean and variance are arithmetically linked, augmenting the system with additional equations will not provide the information necessary to establish the validity or generalizability of statements involving the mean-variance relation. The analytic proofs are supplemented by examples drawn from an empirical study of the U.S. airline industry.

Suggested Citation

  • Timothy W. Ruefli, 1990. "Mean-Variance Approaches to Risk-Return Relationships in Strategy: Paradox Lost," Management Science, INFORMS, vol. 36(3), pages 368-380, March.
    • Handle: RePEc:inm:ormnsc:v:36:y:1990:i:3:p:368-380
    DOI: 10.1287/mnsc.36.3.368
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    Citations

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    Cited by:

    1. Li, Xu & Vermeulen, Freek, 2021. "High risk, low return (and vice versa): the effect of product innovation on firm performance in a transition economy," LSE Research Online Documents on Economics 120268, London School of Economics and Political Science, LSE Library.
    2. repec:zbw:bofrdp:urn:nbn:fi:bof-201508211363 is not listed on IDEAS
    3. Delis, Manthos D. & Hasan, Iftekhar & Tsionas, Efthymios G., 2015. "Firms' risk endogenous to strategic management choices," Bank of Finland Research Discussion Papers 16/2015, Bank of Finland.
    4. Cano Rodríguez, Manuel, 2002. "Is the risk-return paradox still alive?," DEE - Working Papers. Business Economics. WB wb024818, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    5. Johannes M. Lehner, 2000. "Shifts of Reference Points for Framing of Strategic Decisions and Changing Risk-Return Associations," Management Science, INFORMS, vol. 46(1), pages 63-76, January.
    6. Gooding, Richard Z. & Goel, Sanjay & Wiseman, Robert M., 1996. "Fixed versus variable reference points in the risk-return relationship," Journal of Economic Behavior & Organization, Elsevier, vol. 29(2), pages 331-350, March.
    7. Kenneth J. Hatten & James P. Keeler & William L. James, 2018. "Control & Prediction: Reexamining the 2008-2009 US Banking Crisis," Athens Journal of Business & Economics, Athens Institute for Education and Research (ATINER), vol. 4(4), pages 351-374, October.
    8. Palich, Leslie E. & Carini, Gary R. & Seaman, Samuel L., 2000. "The Impact of Internationalization on the Diversification-Performance Relationship: A Replication and Extension of Prior Research," Journal of Business Research, Elsevier, vol. 48(1), pages 43-54, April.
    9. Nickel, Manuel Núñez & Rodriguez, Manuel Cano, 2002. "A review of research on the negative accounting relationship between risk and return: Bowman's paradox," Omega, Elsevier, vol. 30(1), pages 1-18, February.
    10. Kunyu Song & Kenan An & Guang Yang & Jiping Huang, 2012. "Risk-Return Relationship in a Complex Adaptive System," PLOS ONE, Public Library of Science, vol. 7(3), pages 1-8, March.
    11. repec:zbw:bofrdp:2015_016 is not listed on IDEAS
    12. Henkel, Joachim, 2007. "The Risk-Return Paradox for Strategic Management: Disentangling True and Spurious Effects," CEPR Discussion Papers 6538, C.E.P.R. Discussion Papers.
    13. Veliyath, Rajaram & Ferris, Stephen P., 1997. "Agency influences on risk reduction and operating performance: An empirical investigation among strategic groups," Journal of Business Research, Elsevier, vol. 39(3), pages 219-230, July.
    14. Giamouzi, Maria & Nomikos, Nikos K, 2021. "Identifying shipowners’ risk attitudes over gains and losses: Evidence from the dry bulk freight market," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 145(C).
    15. Cano Rodríguez, Manuel, 2002. "Comportamiento heterocedástico entre rentabilidad y riesgo," DEE - Documentos de Trabajo. Economía de la Empresa. DB db021710, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    16. Delis, Manthos & Hasan, Iftekhar & Tsionas, Efthymios, 2015. "Banks’ Risk Endogenous to Strategic Management Choices," MPRA Paper 64907, University Library of Munich, Germany.
    17. Delis, Manthos D. & Hasan, Iftekhar & Tsionas, Efthymios G., 2015. "Firms’ risk endogenous to strategic management choices," Research Discussion Papers 16/2015, Bank of Finland.
    18. repec:bof:bofrdp:urn:nbn:fi:bof-201508211363 is not listed on IDEAS
    19. Farrukh Mahmood & Robert M. Kunst, 2023. "Modeling nonlinear in Bowman’s paradox: the case of Pakistan," Empirical Economics, Springer, vol. 64(5), pages 2357-2372, May.
    20. Deephouse, David L. & Wiseman, Robert M., 2000. "Comparing alternative explanations for accounting risk-return relations," Journal of Economic Behavior & Organization, Elsevier, vol. 42(4), pages 463-482, August.

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