Systematic and Unsystematic Risk - WKU

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 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 2 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 3 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 + 4 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 R R U becomes

Nonsystematic Risk; Systematic Risk; m R R m where m is the systematic risk is the unsystematic risk n Chhachhi/519/Ch. 11 5