Question

Both Beta in the CAPM and the standard deviation measure the risk of any asset. Which of these measures best captures the risk of an asset when we think about the return we expect from that asset? Please explain.

Answer 1

Beta in the CAPM measures only the market risk. CAPM assumes our portfolio is diversified and hence there is no unsystematic risk. So, the return we expect from that particular asset is captured by beta in the CAPM. Again, note that the assumption is that the asset is part of a diversified portfolio.

Standard deviation measures the total risk of the asset. Standard deviation accounts for both systematic risk and unsystematic risk.

Conclusion: So, when we think about the return we expect from this particular asset, the risk is captured by the Standard Deviation.