Systematic Risk

Systematic Risk - The market portfolio has the greatest...

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Systematic Risk and Unsystematic Risk risk ( σ p ) total risk = systematic risk + nonsystematic risk nonsystematic risk market risk ( σ M ) systematic risk number of securities in the portfolio The benefits of portfolio diversification across assets that are not perfectly correlated is that the risk of the portfolio is less than the weighted average of the risks of the individual securities. The risk that is reduced in the portfolio is called the asset's nonsystematic risk , which is also called unique risk, diversifiable risk or firm-specific risk . As more and more securities are added to the portfolio, the nonsystematic risk gets smaller. If the portfolio consists of all securities, i.e. if the portfolio is the market portfolio, all nonsystematic risk is eliminated.
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Unformatted text preview: The market portfolio has the greatest possible diversification, and therefore has eliminated all the diversifiable risk. The market portfolio contains only the risk that cannot be diversified away. The risk of the market portfolio is the systematic risk , which is also called nondiversifiable risk or market risk . Nonsystematic risk can always be eliminated by holding a well-diversified portfolio. Therefore, obtaining the benefits of diversification is "free". Therefore, investors will not receive compensation for nonsystematic risk as is can be eliminated at no cost.--------------Note: Systematic and nonsystematic risk will be examined quantitatively in Topic V....
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This note was uploaded on 09/27/2009 for the course UGBA 133 taught by Professor Distad during the Summer '08 term at Berkeley.

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