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Systematic and Unsystematic Risk

Systematic and Unsystematic Risk. What are the sources of Risk? (pp. 297 - 300). Announcements & Exp. Returns. Actual returns (R) will be : ` R + U (expected + unexpected) Investors form “expectations” about future Expected information is already discounted by the market

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Systematic and Unsystematic Risk

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  1. Systematic and Unsystematic Risk What are the sources of Risk? (pp. 297 - 300)

  2. Announcements & Exp. Returns • Actual returns (R) will be: `R + U (expected + unexpected) • Investors form “expectations” about future • Expected information is already discounted by the market • i.e., the value of the information is already incorporated into the stock prices • Attempts to exploit Public information (make large returns) will not be successful Chhachhi/519/Ch. 11

  3. Surprises • Unexpected Returns: caused by surprises • Surprises can be GOOD or BAD! • Total return (R) = E(R) + U • Announcements are news only to the extent they contain “surprise” element • “No burglary in BG on Sept. 28” --no news • “No burglary in New York on Sept. 28”-- major news! Chhachhi/519/Ch. 11

  4. Systematic vs. Unsys. Surprises • Systematic risk: • surprises that affect “large” no. of assets • Usually in the same “direction” • I/Rs, Unemployment, Elections, GDP,…… • Unsystematic risk: • surprises that affect “small” no. of assets • Some “firm-specific” news turn into “economy-wide” events!!!` • R = `R + U = `R + m + e

  5. Risk: Systematic &Unsystematic We can break down the risk, U, of holding a stock into two components: systematic risk and unsystematic risk:  Total risk; U Nonsystematic Risk;  Systematic Risk; m n Chhachhi/519/Ch. 11

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