Question

Risk Measures: What is the best measure of risk for an asset held in isolation (i.e., comparing risk of one asset to one other asset)? What is the best measure of risk for an asset held in a portfolio?

Answer 1

Best measure of risk for an asset held in isolation is "Coefficient of Variation"

Best measure of risk for an asset held in portfolio is "Beta"

Let me explain both of these below:

• Best measure of risk for an asset held in isolation is "Coefficient of Variation"

Coefficient of Variation measure the variation of the returns of an asset return to the expected return. The same is given as:

Coefficient of Variation = Standard Deviation of Investment / Expected Return

Investors being risk averse, always want to minimise risk on each unit of return. The coefficient of variation can measure the risk of any investment in isolation. Comparing the coefficient of variation of two or more assets, higher the value of coefficient of variation, higher is the risk.

• Best measure of risk for an asset held in a Portfolio "Beta"

Beta is a measure of systematic risk. When you regress the return of an individual asset against the market/portfolio returns, the slope of that regression is known as Beta.

Beta shows why the returns of an asset move in a specific direction (i.e. same direction of the market or the opposite). It shows how volatile an asset is as compared to the portfolio/market. Since its a relative measure, it best describes the risk of an asset held in a portfolio.