Question

In an efficient market, a stock with a standard deviation of returns of 12% could have a higher expected return than a stock with a standard deviation of 10% because the beta for the higher standard deviation stock could be lower than the beta for the lower standard deviation stock. would you agree?

Answer 1

Standard deviation is a measure of firm risk or unsystematic risk of a stock while Beta is the measure of systematic risk of a stock. While individual firm risk or unsystematic risk is an absolute figure, the value of systematic risk or market risk is borne by the movement of the stock with the market , otherwise called the correlation. Hence it is very much possible that despite the higher standard devation,t he stock could have a lower expected return due to lower beta as per CAPM. The formula for expected return as per CAPM = Risk free rate + Beta * market risk premium.

Answer is True