What is independent risk?
Standalone risks are risks associated with a single operating unit of a company, corporate sector or asset rather than a larger, well-diversified portfolio.
- Standalone risks are risks associated with a single aspect of a company or a specific asset.
- Independence risk cannot be mitigated by diversification.
- Total beta measures the volatility of a particular asset by itself.
- Meanwhile, the coefficient of variation (CV) shows the magnitude of the risk associated with an investment relative to the expected return.
Understanding Standalone Risk
All financial assets can be examined in the context of a broader portfolio or independently when the underlying assets are considered isolated. While the portfolio environment considers all investments and assessments when calculating risk, it assumes that the underlying asset is the only investment an investor must lose or gain when calculating independent risk.
Standalone risks represent risks arising from a specific asset, sector or project. It risk measures the dangers associated with a single aspect of a company’s operations, or the risk of holding a particular asset, such as a closely held company.
For a company, calculating standalone risk can help determine the risk of a project as if it were operating as a separate entity. If these operations ceased to exist, the risk would not exist. In portfolio management, stand-alone risk measures the risk of individual assets that cannot be reduced by diversification.
Investors may examine the risk of stand-alone assets to predict the expected return on an investment. Standalone risk must be carefully considered because, as a finite asset, if its value increases, investors will either see high returns, or suffer devastating losses if things don’t go as planned.
Measuring independent risk
Independent risk can be measured by the total beta calculation or the coefficient of variation (CV).
Beta reflects the level of volatility that a particular asset will experience relative to the overall market. At the same time, the total beta, achieved by removing the correlation coefficient from the beta, measures the independent risk of a particular asset, not that it is part of a well-diversified portfolio.
Coefficient of Variation (CV)
CV is a measure used in probability theory and statistics that creates a standardized measure of the dispersion of probability distributions. After CV is calculated, its value can be used to analyze expected return and expected value at risk separately.
A lower CV indicates higher expected return and lower risk, while a higher CV value indicates higher risk and lower expected return. CV is considered particularly useful because it is a dimensionless number, which means that, for financial analysis, it does not need to include other risk factors, such as market volatility.