Unsystematic Risk Does Not Equal Higher Returns

Systematic risk principle states expected return depends solely on asset’s systematic risk. Only the systematic portion is important when determining expected return (and risk premium). For example (Table 3), suppose you owned two assets:

 

Table 3

Systematic Risk and Beta

 

	Std. Dev.	Beta
Asset #1	23%	1.4
Asset #2	44%	0.8

 

While Asset #2 has much more total risk than Asset #1 (44% vs. 23%), Asset #1 is expected to have a higher return since its beta is larger (1.4 vs.0.8). According to A Random Walk Down Wall Street: “If investors did get an extra return (a risk premium) for bearing unsystematic risk, it would turn out diversified portfolios made up of stocks with large amounts of unsystematic risk would give larger returns than equally risk portfolios with less unsystematic risk. Investors would snap at the chance to have these higher returns, bidding up the prices of stocks with large unsystematic risk and selling stocks with equivalent betas but lower unsystematic risk. This process would continue until the prospective returns of stocks with the same betas were equalized and no risk premium could be obtained for bearing unsystematic risk. Any other result would be inconsistent with the existence of an efficient market.”