The term ‘investment risk’ is often used loosely, and frequently confused with the notion of short-term price volatility, particularly for equity instruments. For the long-term investor, however, what is most apposite is the ability to meet future real cash flows as they become due. This paper addresses the concept of economic fundamentals of long-term investment, the objectives of long-term investors (and how these differ from those of short-term investors), the notion of real value shortfall risk, what is meant by an investor’s risk capacity (as opposed to risk appetite) and liquidity management considerations. Subsequently, some of the constraints and barriers to appropriate risk measurement and management are considered, in particular the regulatory and behavioural biases that are overlaid on fundamental asset/liability management. Various alternative approaches to measuring risk, and their appropriateness for purpose, are outlined, in the hope of further informing the discussion and thereby helping to accelerate productive change.

Two essential imperfections determine the degree of the financial sector development in an economy: lending frictions, which constrain the ability to extend loans to borrowers; and, trading frictions, which constrain the trading of these loans in secondary markets. I develop a dynamic general equilibrium model where long-term investment is the engine of growth to study macroeconomic consequences of financial development. In the model, long-term loans are extended to entrepreneurs in a primary market and then traded in a secondary market among financiers. In competitive equilibria, reductions in either lending or trading frictions enlarge the financial sector. Although financial deepening through low-cost lending is always welfare improving, financial deepening stimulated by low-cost trading could be detrimental to the society. I illustrate that a model qualitatively consistent with the U.S. financial development episode of the last 30 years should exhibit disproportionately large reductions in trading frictions relative to lending frictions.

The maximization of the long-term growth rate of expected utility is considered under drawdown constraints. In a general situation, the value and the optimal strategy of the problem are related to those of another ‘standard’ risk-sensitive-type portfolio optimization problem. Furthermore, an upside-chance maximization problem of a large deviation probability is stated as a ‘dual’ optimization problem. As an example, a ‘linear-quadratic’ model is studied in detail: the conditions to ensure the solvabilities of the problems are discussed and explicit expressions for the solutions are presented.