Investment is a complex activity associated with several substantial risks. It can be defined as a process that involves the purchase of assets that are expected to increase in value over time and provide financial returns such as income payments or capital gains (Napoletano & Curry, 2021). Several investments of different assets accumulated together are considered a market portfolio. When considering a general market portfolio or stock market portfolio, it is crucial to consider such factors as market risk and incremental risk.
A stock market portfolio typically includes several investments in public companies. Thus, a single investor can be exposed to several markets through their portfolio and risks related to those markets. According to Hayes (2022), market risk is the probability that an individual investor or an investment entity will experience losses due to various changes in the market. These changes do not affect separate companies but the whole market due to political or economic turmoil, recessions, and other systemic factors. Types of market risk include interest rate, equity, commodity, and currency risks. Fluctuations in interest and currency exchange rates, stock pricing, and commodity costs can lead to meaningful changes in the market that can lead to investment losses (Hayes, 2022). Meanwhile, incremental risk measures the potential consequences of purchasing or selling an investment (Hayes, 2021). Thus, incremental risk aims to determine the impact of one investment on the whole portfolio.
In summary, the market risk and incremental risk factors are crucial when looking at a stock market portfolio. Market risk helps understand the influence of systemic market factors on the investor’s portfolio, whereas incremental risk considers the effect of a single investment on the portfolio. Both factors help define how to manage a stock market portfolio and what positions should be invested in or liquidated.
References
Hayes, A. (2021). What is incremental value at risk? Investopedia.
Hayes, A. (2022). Market risk. Investopedia.
Napoletano, E., & Curry, B. (2021). What is investing? How can you start investing? Forbes Advisor.