Hello everyone,
I’m in doubt about this point. Systematic risk (beta) cannot be diversified, but it can be reduced by adding more stocks and allocating assets. For example, we have 1 stock with beta=0.5 and if we combine it with another stock having beta=0.3 (say allocate 50-50), we have a portfolio with its beta=0.4. However, when beta is reduced, the expected return is also smaller.
Is it correct?
Thanks.
Unsystematic risk (i.e. company specific or sector) can be diversified away.
Systematic risk (i.e. market) cannot be diversified away.
Beta measures a security’s or portfolio’s volatility vs. the market. A beta less than 1 is less volatile than the market (lower risk, lower expected return/loss) and greater than 1 is more volatile than the market (higher risk, higher expected return/loss)
Yes, and beta refers to systematic risk, and it can be reduced, but the return is accordingly lower, whereas unsystematic risk can be diversified without lowering the return. Is it correct?
No, it doesn’t.
Relative volatility (of returns) is only one factor in beta; the other factor is the correlation of returns.
Again: no, it doesn’t.
A stock can have a beta of, say, 0.5 with relative volatility of returns of 2.0 and correlation of returns of 0.25. Its returns are twice as volatile as the market’s returns, but its beta is less than 1.
Systematic risk can not be reduced by diversification since, systematic risk is affected by wide economic uncertainties like increase in inflation, change in interest rates and increase in capital gain tax rate thus every individual security will be affected, and also the individual securities in systematic risk move together with changes in market.