2 3 4 5 it should come up with a measure of risk that

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: second is the symbol for “opportunity”, making risk a mix of danger and opportunity. You cannot have one, without the other. Risk is therefore neither good nor bad. It is just a fact of life. The quesJon that businesses have to address is therefore not whether to avoid risk but how best to incorporate it into their decision making. Aswath Damodaran 70 A good risk and return model should… 71 1.  2.  3.  4.  5.  It should come up with a measure of risk that applies to all assets and not be asset- specific. It should clearly delineate what types of risk are rewarded and what are not, and provide a raJonale for the delineaJon. It should come up with standardized risk measures, i.e., an investor presented with a risk measure for an individual asset should be able to draw conclusions about whether the asset is above- average or below- average risk. It should translate the measure of risk into a rate of return that the investor should demand as compensaJon for bearing the risk. It should work well not only at explaining past returns, but also in predicJng future expected returns. Aswath Damodaran 71 The Capital Asset Pricing Model 72 1.  2.  3.  4.  Uses variance of actual returns around an expected return as a measure of risk. Specifies that a porJon of variance can be diversified away, and that is only the non- diversifiable porJon that is rewarded. Measures the non- diversifiable risk with beta, which is standardized around one. Translates beta into expected return - Expected Return = Riskfree rate + Beta * Risk Premium 5.  Works as well as the next best alternaJve in most cases. Aswath Damodaran 72 1. The Mean- Variance Framework 73 ¨༊  The variance on any investment measures the disparity between actual and expected returns. Low Variance Investment High Variance Investment Expected Return Aswath Damodaran 73 How ris...
View Full Document

This document was uploaded on 02/03/2014.

Ask a homework question - tutors are online