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Portfolio Specific Risk is a measure of risk outside of those risks associated with a market or benchmark portfolio. To find portfolio specific risk, a regression of returns is run and portfolio variance is decomposed into a systematic component and a specific component.
Synonyms: portfolio residual risk, portfolio unsystematic risk
The two measures required from a regression of portfolio returns versus market returns include the portfolio's beta and the residual from the regression. In the end, the two component parts of variance can be isolated and are additive.
The Beta^2 above means beta is squared. Standard Error refers to the square root of variance of the residual from the regression, which represents the firm-specific uncertainty.
For context, most individual and small professional investment advisory firms don't decompose risk into systematic and unsystematic components, but will supplement their analysis with R-squared which is related in that it shows the percent of variance related to systematic factors.
Sue: What's the main takeaway from providing
portfolio specific risk for this new product?
Eve: It's so consultants can see if we're active enough to justify our fees.
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False. It is related to higher active risk.
Still unclear on Portfolio Specific Risk? Check out the Quant 101 Series, and specifically the tutorial titled Stock portfolio risk decomposition into systematic and risk and specific risk.
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