Risk-Return Analysis

Dirk Schoenmaker and Willem Schramade
Additional contact information
Willem Schramade: Nyenrode Business University

Chapter 12 in Corporate Finance for Long-Term Value, 2023, pp 325-366 from Springer

Abstract: Abstract Risk-return analysis is central to financial decision-making. The basic idea is that risk-averse investors ask compensation for higher risk, in the form of a risk premium on risky assets. The key insight of portfolio theory is that a company’s risk, at least as measured by the distribution of its historical stock returns, can be split into systematic or market-wide risk and idiosyncratic risk. As idiosyncratic risk can be diversified away in a portfolio, investors are only rewarded with a risk premium for the market risk component. This is the beta of the Capital Asset Pricing Model. But historical risk-return analysis has limitations in accurately assessing current and future financial risk. We therefore explore forward-looking measures of financial risk and return. Moreover, we expand the single-factor market model to a multifactor model by adding social and environmental factors. Yet, another step is to assess social and environmental risk in their own right, as well as their impact on integrated risk. This, in turn, allows us to estimate the cost of integrated capital, which should give corporate managers the tools to make that assessment in their investment decisions. Company examples show that integrated risk-return analysis leads to different, and more sustainable, decisions.

Keywords: Adaptive markets hypothesis; Beta; Capital asset pricing model (CAPM); Capital market line; Correlation; Cost of integrated capital; Efficient markets hypothesis; Environmental factor; Expected return; Factor models; Factor portfolio; Idiosyncratic risk; Integrated risk; Integrated risk-return analysis; Loss aversion; Market portfolio; Market-wide risk; Multifactor model; Realised return; Risk; Risk-averse investors; Risk-free asset; Risk premium; Risk-return analysis; Risky assets; Scenario analysis; Social discount rate; Social factor; Systematic risk (search for similar items in EconPapers)
Date: 2023
References: Add references at CitEc
Citations:

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:spr:sptchp:978-3-031-35009-2_12

Ordering information: This item can be ordered from
http://www.springer.com/9783031350092

DOI: 10.1007/978-3-031-35009-2_12

Access Statistics for this chapter

More chapters in Springer Texts in Business and Economics from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().