Measuring Market Risk

While most risk and return models in use in corporate finance agree on the first two step of this process, i.e., that risk comes from the distribution of actual returns around the expected return and that risk should be measured from the perspective of a marginal investor who is well diversified, they part ways on how to measure the non-diversifiable or market risk. In this section, we will provide a sense of how each of the four basic models - the capital asset pricing model (CAPM), the arbitrage pricing model (APM) and the multi-factor model - approaches the issue of measuring market risk.

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