Systematic risk
Risk that cannot be diversified away because it moves the whole market. The only kind anyone is compensated for holding.
Where you will meet it
Systematic risk appears in 10 learning outcomes on the CFA syllabus. A few of them:
- Explain what security market indexes are used for
“Indexes serve as gauges of market sentiment, as proxies for measuring and modelling returns, as proxies for systematic risk in asset pricing models, as benchmarks for active managers, as the basis for asset allocation models, and as the underlying for index funds and derivatives.”
- Derive a stock's alpha and beta by regressing its excess returns on those of the market
“The slope is beta, cov(stock, market) / var(market), which can also be written correlation x sd(stock) / sd(market); it measures systematic risk.”
- Work out a required return with the capital asset pricing model
“Its central claim is that only systematic risk is rewarded: risk specific to one company can be diversified away at no cost, so no investor should be paid for bearing it.”
- Explain how the value that active management adds is gauged
“Value added is the return on the actively managed portfolio minus the return on its benchmark, where the benchmark should carry the same systematic risk as the portfolio.”
Learn it properly
Practise it
Practise systematic risk until it is automatic: questions that explain every wrong option.
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