In developing the CAPM, the relevant measure of risk for each security is its
A) individual standard deviation.
B) weight or proportion of the portfolio.
C) correlation with each alternative security.
D) covariance with the market portfolio.

Question

Quizplus · Accepted Answer

The relevant measure of risk for each security in developing the CAPM is its covariance with the market portfolio. This is because the CAPM is a single-factor model that assumes that the only risk that investors are concerned about is the risk that cannot be diversified away, which is systematic or market risk. The covariance between a security and the market portfolio captures the degree to which the security's returns move with the market's returns, and hence its exposure to systematic risk. The other choices do not capture systematic risk but rather only idiosyncratic or diversifiable risk.

In Developing the CAPM, the Relevant Measure of Risk for Each