Risk Measures
What Are Risk Measures?
Risk measures are statistical measures that are historical predictors of investment risk and volatility, and they are additionally major parts in modern portfolio theory (MPT). MPT is a standard financial and scholastic methodology for evaluating the performance of a stock or a stock fund as compared to its benchmark index.
There are five principal risk measures, and each measure provides a unique method for surveying the risk present in investments that are under consideration. The five measures incorporate the alpha, beta, R-squared, standard deviation, and Sharpe ratio. Risk measures can be utilized exclusively or together to perform a risk assessment. While comparing two possible investments, it is astute to compare like for like to determine which investment holds the most risk.
Understanding Risk Measures
Alpha
Alpha measures risk relative to the market or a chose benchmark index. For instance, assuming that the S&P 500 has been considered the benchmark for a particular fund, the activity of the fund would be compared to that experienced by the chose index. On the off chance that the fund outperforms the benchmark, having a positive alpha is said. On the off chance that the fund falls below the performance of the benchmark, having a negative alpha is considered.
Beta
Beta measures the volatility or systemic risk of a fund in comparison to the market or the chose benchmark index. A beta of one shows the fund is expected to move related to the benchmark. Betas below one are considered less unstable than the benchmark, while those over one are considered more unpredictable than the benchmark.
R-Squared
R-Squared measures the percentage of an investment's movement attributable to movements in its benchmark index. A R-squared value represents the correlation between the inspected investment and its associated benchmark. For instance, a R-squared value of 95 would be considered to have a high correlation, while a R-squared value of 50 might be considered low.
The U.S. Treasury Bill capabilities as a benchmark for fixed-income securities, while the S&P 500 Index capabilities as a benchmark for equities.
Standard Deviation
Standard deviation is a method of measuring data dispersion in regards to the mean value of the dataset and provides a measurement regarding an investment's volatility.
As it relates to investments, the standard deviation measures how much return on investment is digressing from the expected normal or average returns.
Sharpe Ratio
The Sharpe ratio measures performance as adjusted by the associated risks. This is finished by removing the rate of return on a risk-free investment, like a U.S. Treasury Bond, from the experienced rate of return.
This is then separated by the associated investment's standard deviation and serves as an indicator of whether an investment's return is due to shrewd investing or due to the assumption of excess risk.
Highlights
- Risk measures are likewise major parts in modern portfolio theory (MPT), a standard financial methodology for evaluating investment performance.
- The five principal risk measures incorporate the alpha, beta, R-squared, standard deviation, and Sharpe ratio.
- Risk measures are statistical measures that are historical predictors of investment risk and volatility.
