tl;dr
Risk is a commodity that can be bought and sold. As with any commodity, risk can be bought and sold for a profit if one has a better estimate for the value of the risk. The value of the risk is based on the Probability of the risk event happening and the median Cost of the risk event if it happens.
Financial risk arises from uncertainty about financial returns. It includes market risk, credit risk, liquidity risk and operational risk.
In finance, risk is the possibility that the actual return on an investment will be different from its expected return. This includes not only "downside risk" (returns below expectations, including the possibility of losing some or all of the original investment) but also "upside risk" (returns that exceed expectations). In Knight’s definition, risk is often defined as quantifiable uncertainty about gains and losses. This contrasts with Knightian uncertainty, which cannot be quantified.
Financial risk modeling determines the aggregate risk in a financial portfolio. Modern portfolio theory measures risk using the variance (or standard deviation) of asset prices. More recent risk measures include value at risk.
Because investors are generally risk averse, investments with greater inherent risk must promise higher expected returns.[29]
Financial risk management uses financial instruments to manage exposure to risk. It includes the use of a hedge to offset risks by adopting a position in an opposing market or investment.
A hedge is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, gambles,[1] many types of over-the-counter and derivative products, and futures contracts.
A hedge must have some value to both the buyer and seller. The buyer places value on the ability to limit downside risks and the seller must receive a price that makes up for the risk that may happen. We value the Risk by determining
the uncertainty of an event and
the cost of an event happening
Risk = Probability x Cost
In order to find the fair price for trading the risk we need to be able to properly estimate the probability of the event happening and the median cost should the event happen.