There is a saying in portfolio investing, but the original meaning of a portfolio is a file folder or briefcase. Just as there are many different types of documents in a briefcase, it means that investments must be diversified in multiple targets to reduce investment risk and achieve a desired rate of return for successful investment.
The essence of portfolio investing is risk diversification, and the goal is to reduce investment risk under the condition that it can produce an appropriate rate of return. For example, stock investment risk refers to the volatility of stock investment returns and is usually measured as variance or standard deviation.
But what are the factors that cause stock prices to fluctuate? First, consider the case where the stock price rises. 'The company succeeded in developing a new product that the world is paying attention to', 'The company won a large-scale project in an oil-producing country', 'Korea's successful bid for the 1988 Seoul Olympics', and 'Achieving peaceful unification of the Korean Peninsula' are examples of stock price rises.
The following situations cause the stock price to fall. 'The manufacturer's factory caught on fire', 'The company lost a lawsuit and has to pay large compensation', 'Business is in a mess due to the novel coronavirus infection (COVID-19)', 'Credit crunch caused by the global financial crisis' Due to difficulties in raising capital, timely investments are not being made.”
As the stock price fluctuates for a variety of reasons, the investment risk of the corresponding stock increases.
Among the examples of stock price fluctuations mentioned above, the first two are unsystematic risks and the latter two examples are systematic risks. The fluctuation of the stock price of an individual company according to the special circumstances of that company is an unsystematic risk and has nothing to do with the market flow.
CAPM, Fundamentals of Financial Risk Management
By investing in a portfolio, you can diversify your risk and lower the volatility of your investment return. However, there is a limit to the risk reduction effect of portfolio investment.
Unsystematic risk can be reduced according to the risk diversification of portfolio investment, but systematic risk linked to market movements has no bearing on risk diversification. This means that no matter how wealthy and well-informed investors are, individual investments cannot go against the big market trend.
How can a single-leaf yacht go up against the huge turbid flow of the Yellow River or the Yangtze River? After all, investors who diversify their portfolios in the many assets that exist in the market today can almost completely eliminate so-called unsystematic risk, but systematic risk has nothing to do with it.
The Capital Asset Pricing Model (CAPM), which shows the relationship between systematic risk beta (β) and return on investment, has made it easy to analyze the equilibrium price of an asset, which every investor wants to know.
The systematic risk beta of a specific asset has its own unique value, which can be easily obtained through regression analysis if there is data for a certain period of time. If only the beta value obtained in this way and the information shared with the market, the risk-free asset return (eg, government bond yield) and market portfolio return (eg, KOSPI average return), are inserted into the equation, the equilibrium rate of return for a specific asset is calculated.
Being able to calculate the expected rate of return means being able to predict the future price of an asset, such as a stock. Now, the investor's job is to compare the theoretical stock price calculated in this way with the stock price formed in the market today and make an arbitrage deal. Buy low and sell high.
CAPM, which can easily estimate the price of an asset that investors desperately want to know, is a revolutionary valuation model. Harry Markowitz, William Sharp, and Merton Miller, who developed it, were awarded the 1990 Nobel Prize in Economics.
CAPM is the model that laid the foundation for Financial Risk Management (FRM) and is the father of the Arbitrage Pricing Theory and Option Pricing Model.
