# Capital Asset Pricing Model (CAPM) and Beta

In the Capital Asset Pricing Model (CAPM) why do we use beta ÃŸ, rather than standard deviation of returns, as our measure of risk? Why is it that the formula for beta fits in with the meaning of beta as non-diversitifiable risk?

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## SOLUTION This solution is **FREE** courtesy of BrainMass!

In the Capital Asset Pricing Model (CAPM), beta is the preferred measure of risk for a portfolio due to its non-diversifiability, in stark contrast to standard deviation risk which can be diversified away. The standard deviation of a stock reflects how much random noise the stock exhibits. The beta is the ratio of risk relative to the stock market. So a 2.0 beta means that when the market moves X%, the portfolio with a beta of 2 can be expected to move 2*X%. While standard deviation of a stock can be diversified away, the beta reflects the riskiness of the portfolio of assets relative to some benchmark. The aggregation of many stocks into a portfolio will diversify away the random noise, such that in a pool of stocks so that beta is the only measure of risk that remains.

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