Specific risk can be reduced by diversification, or investing in a basket of different assets-a concept that’s at the heart of modern portfolio theory (MPT). These risks are not correlated across different assets, unlike systemic risk. Individual stocks face risks from adverse developments at companies that may not impact any other peer firms, for instance.

Also known as specific risk, these are risks that are unique to each asset.

Systemic risk applies to the market as a whole, which means that all assets are impacted in similar ways. It is influenced by factors such as interest rates, inflation, recessions and geopolitical events like war. Also called market risk, this is general risk from developments impacting the entire economy and all investment assets. In the CAPM framework, he identified two types of risk: Sharpe was looking at diversification, more specifically which risks can be dealt with by diversification and which cannot. His research led to the capital asset pricing model, which he introduced in his 1970 book, “ Portfolio Theory and Capital Markets.” He took up the question of how risk-more specifically, risk that could not be diversified away-influenced returns. The CAPM was conceived in the early 1960s by William Sharpe, an economist and academic. Understanding the Capital Asset Pricing Model The capital asset pricing model (CAPM) helps investors understand the returns they can expect given the level of risk they assume.

In other words, the more risk you take on, the higher returns you hope to earn. A bedrock principle of all investing is that returns are directly proportional to risk.

Capital asset pricing model formula