What it means
When you look at a single asset in isolation, its risk is the chance that actual results will differ from what you expect. If a project could return anywhere between a large loss and a large gain, it has high standalone risk, and if the outcomes cluster tightly around the expected figure, it has low standalone risk.
This is the simplest view of risk and the one a decision-maker sees first. The usual measures are the standard deviation of returns, which shows how far results typically stray from the average, and the coefficient of variation, which divides that spread by the expected return.
The second measure helps compare projects of different sizes and returns because it gives risk per unit of expected return. A lower coefficient means you take on less risk for each dollar of expected gain.
Standalone risk is where analysis starts, especially in corporate project appraisal. Managers estimate a range of outcomes for a new product or factory, assign probabilities to scenarios and calculate the spread.
It is also what a business owner with a single venture, or an investor with only one holding, actually experiences. The contrast is with market risk and corporate risk.
Market risk, often measured by beta, considers only the part of an asset's risk that cannot be diversified away in a large portfolio. For a well-diversified shareholder that is the relevant figure, while standalone risk matters most to people who cannot diversify.
A nuance is that standalone risk overstates the risk to a diversified investor. An asset that jumps around but moves differently from the rest of the portfolio can reduce overall risk.
Likewise, the standalone figure depends on estimates of probabilities and outcomes, so it is only as good as the assumptions behind it. In practice, managers look at standalone risk alongside other views rather than in place of them.
A small firm may rely on it because its owners hold most of their wealth in the business, while a large listed company may place more weight on market risk. Knowing which lens fits your situation is half the battle.
In practice
Real-world examples.
Example
A founder owns a single bakery and has most of her savings in it. She looks at the range of possible profits for the next year and sees a wide spread. Because she cannot diversify, standalone risk is what she faces.
Example
A finance team compares two projects: one with an expected return of 12% and a standard deviation of 6%, the other with an expected return of 20% and a standard deviation of 16%. The coefficients of variation are 0.5 and 0.8. The first project carries less risk per unit of return.
Example
An investor holding one volatile technology share reviews its price history. The wide swings show high standalone risk, and she decides to spread her money across more holdings. Her overall portfolio becomes steadier even though each share is just as volatile.
Formula
Calculation
Expected return = Sum of (probability x return)
Standard deviation = Square root of Sum of (probability x (return - expected return) squared)
Coefficient of variation = Standard deviation / Expected return
Suppose a $100,000 project has a 50% chance of returning 20% and a 50% chance of returning 0%. The expected return is 0.5 x 20% + 0.5 x 0% = 10%, which is $10,000 on $100,000. The variance is 0.5 x (20 - 10) squared + 0.5 x (0 - 10) squared = 0.5 x 100 + 0.5 x 100 = 100, so the standard deviation is 10%, or $10,000. The coefficient of variation is 10% / 10% = 1.0, meaning one unit of risk for each unit of expected return.Case study
Seen in the real world.
Orchard Lane Foods is a fictional food manufacturer assessing a new line of frozen meals. The finance team of this illustrative company estimates three scenarios for first-year profit: weak, expected and strong. This is a fictional case, not a real firm.
The calculation shows an expected profit of $400,000 with a standard deviation of $300,000, a coefficient of variation of 0.75. The board compares this with a second proposal, a packaging upgrade, whose coefficient is 0.3, and decides to fund the upgrade first. It also asks for a plan to reduce the frozen meals project's risk through a pilot launch.
Watch out
Common mistakes.
- Treating standalone risk as the only risk that matters. A diversified investor cares mainly about the part of risk that remains after diversification.
- Comparing projects using standard deviation alone. A larger project naturally has a bigger spread, so the coefficient of variation is a fairer comparison.
- Trusting the number more than the inputs. The result depends on the scenarios and probabilities, which are estimates.
Questions
People also ask.
What is the difference between standalone risk and market risk?
Standalone risk looks at an asset by itself, while market risk is the part that cannot be removed by diversification.
When is standalone risk the right measure?
It is most relevant when the owner cannot diversify, such as a single-venture business or a one-asset investor.
Can standalone risk be reduced?
Yes, through staging investment, pilots, contracts that fix prices or costs, insurance and spreading effort across several projects.
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