... look at the model, we must understand how the concept was derived. Stanford professor William Sharpe and the late finance specialists John Lintner and Fischer Black focused on calculating what part of a security's risk can be eliminated by diversification and what part cannot. The result was the capital asset pricing model. The basic concept behind the model is that there is no premium for bearing risks that can be diversified away (unsystematic/specific risk). Fig.1: How diversification reduces risk Consequently, to get a higher than average long run return, one must increase the risk level that cannot be diversified away (systematic/market risk). According to this theory, investors can win the profit race simply by adjusting their portfolio by a risk measure known as beta. Market risk captures the reaction of a security to the general market. Some stocks tend to be very sensitive to market movements. Others are less volatile. This relative sensitivity ...

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