Abstract
The objective of this paper is to revisit the concepts of diversifiable and non-diversifiable risk, expound the portfolio risk in two ways: mathematically first, and with practical examples, second It also explains lending and borrowing at the risk-free rate of return, in addition to juxtaposing the diversification method to measure the unsystematic risk against utilizing Beta to measure the systematic risk. Furthermore, it briefly examines the mathematical simulation and sensitivity analysis, and mathematically delineates the technique for choices under risk, ambiguity, and uncertainty. The practical implication of this conceptual paper is to offer a further clarification of theoretical terms, especially those which might be interchangeable in financial and economic literature, and further show, by examples, the terms’ applicability.
Highlights
Research on risk, its measurement and tolerance in the context of market and business investment has been around and been advancing for the last hundred years or so
With that relatively long history of literature, there has been a diversity of perceptions and a variety of applications, whose approaches depended on who was adopting them! whether they were academics and theorists, empirical researchers, or corporate practitioners
The empirical researchers have discovered that some constructs such as the major statistical measures necessary for diversification like variance and covariance of security returns fluctuate over time, and they vary between short and long run
Summary
Its measurement and tolerance in the context of market and business investment has been around and been advancing for the last hundred years or so. The objective of this paper is to revisit the concepts of diversifiable and non-diversifiable risk, expound the portfolio risk in two ways: mathematically first, and with practical examples, second. It explains lending and borrowing at the risk-free rate of return, in addition to juxtaposing the diversification method to measure the unsystematic risk against utilizing Beta to measure the systematic risk. It briefly examines the mathematical simulation and sensitivity analysis, and mathematically delineates the technique for choices under risk, ambiguity, and uncertainty. The practical implication of this conceptual paper is to offer a further clarification of theoretical terms, especially those which might be interchangeable in financial and economic literature, and further show, by examples, the terms’ applicability
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