What does the Standard Deviation measure in the context of risk?

Standard deviation is a statistical measure that describes the dispersion or variability of a set of data points around their mean. In the context of risk in portfolio management, it serves as an important indicator of total risk associated with an asset or a portfolio of assets.

When evaluating a portfolio, standard deviation captures both systematic risk, which is the risk inherent to the entire market or market segment, and unsystematic risk, which refers to the risk specific to a particular asset or company. By encompassing both types of risk, standard deviation provides a comprehensive picture of how much the returns on an asset are likely to deviate from their expected returns over a specific period.

This total risk perspective is crucial for investors because it helps them understand not only the broad market influences (systematic risk) that can affect their investments but also the individual factors (unsystematic risk) that could lead to fluctuating returns. Thus, measuring all aspects of risk allows investors to better assess volatility and make informed decisions about portfolio construction and risk management strategies.