Editing Capital asset pricing model (section)

==Risk and diversification==
The risk of a [[portfolio (finance)|portfolio]] comprises [[systematic risk]], also known as undiversifiable risk, and [[Specific risk|unsystematic risk]] which is also known as idiosyncratic risk or diversifiable risk. Systematic risk refers to the risk common to all securities—i.e. [[market risk]]. Unsystematic risk is the risk associated with individual assets. Unsystematic risk can be [[Diversification (finance)|diversified]] away to smaller levels by including a greater number of assets in the portfolio (specific risks "average out"). The same is not possible for systematic risk within one market. Depending on the market, a portfolio of approximately 30–40 securities in developed markets such as the UK or US will render the portfolio sufficiently diversified such that risk exposure is limited to systematic risk only. This number may vary depending on the way securities are weighted in a portfolio which alters the overall risk contribution of each security. For example, market cap weighting means that securities of companies with larger market capitalization will take up a larger portion of the portfolio, making it effectively less diversified. In developing markets a larger number of securities is required for diversification, due to the higher asset volatilities.

A rational investor should not take on any diversifiable risk, as only non-diversifiable risks are rewarded within the scope of this model. Therefore, the required [[Return on investment|return]] on an asset, that is, the return that compensates for risk taken, must be linked to its riskiness in a portfolio context—i.e. its contribution to overall portfolio riskiness—as opposed to its "stand alone risk". In the CAPM context, portfolio risk is represented by higher [[variance]] i.e. less predictability. In other words, the beta of the portfolio is the defining factor in rewarding the systematic exposure taken by an investor.