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Main Dictionary D

Dispersion

Dispersion is a concept widely used in statistics and characterizes the value distribution size ​​expected for a certain variable. Dispersion can be determined using various statistics such as range, variance, and standard deviation. The term dispersion is also applicable to the financial sector, where it usually acts as a kind of indicator of the spectrum of potential returns on investments. In addition, a dispersion can show the risk degree of a definite security in the investor’s portfolio.

What is Dispersion

The average investor has many potential opportunities and a wide selection for acquiring securities and investing his money. However, the investor should pay special attention to such a factor as the risk profile. Dispersion is an important tool that helps investor to get a complete overview in this issue. 

Information about particular stocks can be found on the Internet in published fact sheets and prospectuses, as well as on analytical resources and rating sites, such as Morningstar.

The more variable the return on an asset, the more it is risky and volatile, since the dispersion of return on an asset demonstrates the volatility and risk of the asset in the stockholder’s portfolio. The lower the dispersion, the safer the financial instrument is. As an example, an asset with historical return varies from +5% to -5% is admitted more volatile than another one with historical return varies from +1% to -1% since its returns are more extensively dispersed. 

Dispersion measuring

Dispersion can be calculated through the use of alpha and beta, where beta is a measure of compliance with a certain standard, and alpha measures risk-adjusted returns.

Beta. This indicator is able to assess the degree of primary risk and determine the dispersion of the security's return in relation to a certain reference standard or market index.

If a beta equals to 1.0, it means the correlation with the market and the compliance of the asset to the established standard. This is a kind of neutral position in which the risk of the portfolio does not increase, but its return does not boost either.

If a beta of a stock equals to 1.1, for example (more than 1.0), it means that this stock is expected to be 10% more volatile than the market, and if the market falls, this stock with a high probability will fall more. In addition, this dispersion demonstrates that by adding such a stock to his portfolio, the investor will increase the whole portfolio risk, but at the same time, its expected return may also increase.

If a beta of a stock equals to 0.7, for example (less than 1.0), it means that the market more volatile than this security in theory. The good point is that such a stock is less risky. At the same time, if the market rises by 10%, the expected growth of such a stock will be only 7%, since it has a tendency to move slower than the market on an average.

Alpha. The indicator that shows the risk-adjusted returns on a portfolio is called alpha. It demonstrates the stock return relative to the market index or beta. If a return is higher than the beta, this means a positive alpha and also the success of the portfolio management model. And vice versa, a negative alpha signals the fail of the portfolio manager in beating  the beta or even the market.

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