3.4 THE CAPITAL-ASSET-PRICING MODEL (CAPM)

3.4.1 Systematic Risk versus Unsystematic Risk

The preceding section shows how portfolio risk can be reduced through diversification. However, diversification reduces only a particular type of risk. From this point of view, a particular asset or a portfolio of asset possesses two types of risk: first, the unsystematic risk that can be diversified away and; second, the systematic risk that cannot be diversified away through investment in domestic securities.

 

The unsystematic risk is firm-specific and so simultaneous investment in other securities may lower it. On the other hand, systematic risk is a macroeconomic risk, inherent in the performance of the economy as a whole.

The unsystematic risk is ...

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