How do I calculate the market risk?
There are various methods to calculate market risk, but one commonly used formula is the Capital Asset Pricing Model (CAPM). The CAPM estimates the expected return on an investment based on its systematic risk, which is a measure of the investment's sensitivity to overall market movements. Here is the formula for calculating the expected return using CAPM:
Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)
In this formula:
- Risk-Free Rate: The rate of return on a risk-free investment, such as a government bond. It represents the compensation for bearing no risk.
- Beta: Beta measures the systematic risk of an investment relative to the overall market. It indicates how much the investment's returns move in relation to the market returns. A beta of 1 indicates the investment moves in line with the market, while a beta greater than 1 suggests higher volatility, and a beta less than 1 indicates lower volatility.
- Market Return: The expected return of the overall market.
Please note that the CAPM has its limitations and assumptions, and there are other models and approaches available for measuring market risk, such as the Fama-French Three-Factor Model, Arbitrage Pricing Theory (APT), and Value at Risk (VaR). The choice of model depends on the specific requirements and characteristics of the investment or portfolio being analyzed.
What is Market risk?
Market risk is the risk of loss resulting from changes in the market, such as interest rates, currency exchange rates, commodity prices, and equity prices.