What does the term "financial equilibrium" imply?

The term "financial equilibrium" implies that supply and demand are balanced for expected risk and return. In this context, financial equilibrium occurs when the quantity of a financial asset that investors are willing to buy equals the quantity that others are willing to sell at a given price, factoring in the expected risks and returns associated with those assets.

In an equilibrium state, asset prices reflect all available information, and investors have no incentive to change their current positions. They have assessed the risks and potential returns of an asset such that they perceive no arbitrage opportunities, meaning that they cannot find a way to achieve a higher return without taking on additional risk. This balance is crucial for efficient market functioning, as the assets traded reflect their true value based on collective investor expectations.

Understanding equilibrium helps investors grasp how markets operate in terms of pricing and resource allocation, making it an essential concept in both theoretical finance and practical investing.