Unformatted text preview: matic risk
o Non-diversifiable risk
o Changes in the general economy or major political events such as
changes in general interest rates, changes in corporate taxation, etc. As diversification allows investors to essentially eliminate the unique risk, a well-diversified investor will
only require compensation for bearing the market risk of the individual security. Thus, the expected return
on an asset depends only on the market risk. 5.3 Measuring market risk
Market risk can be measured by beta, which measures how sensitive the return is to market movements.
Thus, beta measures the risk of an asset relative to the average asset. By definition the average asset has a
beta of one relative to itself. Thus, stocks with betas below 1 have lower than average market risk;
whereas a beta above 1 means higher market risk than the average asset. Download free ebooks at bookboon.com
31 Corporate Finance Risk, return and opportunity cost of capital Estimating beta
Beta is measuring the individual asset's exposure to market risk. Technically the beta
on a stock is defined as the covariance with the market portfolio divided by the
variance of the market: (27) Ei covariance...
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