MAF203 Lecture Notes - Lecture 3: Market Risk, Standard Deviation, Capital Asset Pricing Model
Document Summary
Diversification = is a process of minimising investment losses by spreading investment to a variety of assets that are not highly correlated. Simply we are expecting the positive performance of some investments to offset the negative performance of others. The degree of gain from diversification (risk reduction) increases as the correlation between the rates of return on two securities decreases: r = +1: perfectively positive correlated. 0 < r < 1: less than perfectively positive correlated. Some risk reduction. r = < 0: negatively correlated. That is, investors can diversify away only the risk unique to individual assets, but cannot diversify away risk common to all assets (i. e. , systematic risk). Systematic risk = market risk that is due to economy wide factors and cannot be diversifiable. Only systematic risk is rewarded in asset markets. That is why our only concern is systematic risk regarding relationship between risk and return in finance.
