Question

If holding assets in a diversified portfolio, why is beta, and not standard deviation, the appropriate measure of risk for an individual asset? 6. If holding assets in a diversified portfolio, why is standard deviation the appropriate measure of risk for the portfolio? 7.

Answer 1

6. In case of a diversified portfolio, the risks of assets are balanced by one another, resulting in a beta for the portfolio, which measures the risk of the portfolio. So, when considering the risk of an individual asset, the beta should be considered instead of the standard deviation. Standard deviation would give the wrong estimate because it would give the risk of the asset alone, though the risk can be diversified away by the portfolio

7. In a diversified portfolio, the appropriate measure of risk of the portfolio is the standard deviation. This is because it gives an idea as to how varying the returns of the portfolio can be, which is what risk measures.