Question

Differentiate standard deviation and beta coefficient as measure of risk ----- what makes these two measures different from each other? Explain why larger standard deviations and higher beta coefficients indicate increased risk.

Answer 1

Standard deviation will be measuring the overall deviation of the return of a Portfolio from the actual standard.

Beta is a representation of the volatility of the stock in respect to the market.

When we will be comparing them in respect to the risk represented then, beta is a representation of systematic risk whereas standard deviation is a representation of the total risk associated with the portfolio

Beta of the portfolio can be calculated after weighting out various components of the portfolio but standard deviation of the portfolio cannot be weighted out of each particular component.

They are different from each other because one portfolio may have a higher standard deviation but it will have a low beta or another portfolio may have a lower standard deviation and it will have a higher beta so they are different because they are representative of different element.

Increased beta and increased standard deviation will be representative of increased risk because standard deviation is a measure of total risk whereas beta will be measuring the systematic risk so when there will be increase in both the component, it will mean that there will be higher sensitivity of stock to the overall market and it will also mean that the variation in the rate of return will also increase with the higher pace