Risk, Capital Asset Pricing, and Accounting Numbers

Risk assessment and management is an important component of a firm’s corporate governance particularly in small undiversified firms. In a review of the literature Ryan (1997) discusses five motivations for relating accounting research to measures of systematic risk: (i) the development of more efficient ex post risk measures, (ii) the determination of actual risk determinants rather than just determining the level of risk, (iii) overcoming the problem that conventional ex-post measures cannot be used for non-listed entities, initial public offering firms, or those that do not have sufficient trading history, (iv) as instrumental variables to reduce the noise found in traditional risk estimates that rely on historical security returns, and (v) the development of trading strategies and the construction of portfolios with the desired level of risk. Ubiquitous risk faces firms and intensifies in global economy. A success business not only centers on profit, but also on proper risk management. Risk and return go together and return maximization is constrained by risk. Firm risk has the systemic and unsystematic components. Portfolio theory suggests that unsystematic risk can be diversified away while systematic risk remains. How to control systematic risk through proper identification of its determinants thus becomes imperative for successful risk management and to investment decision. The finance literature suggests that systematic risk has external and internal factors. This e-book aims to advance the debate in this area and build on the existing literature.