The Single Index Model: Its Background and Application

Managing risk means selectively choosing production, marketing and investment alternatives and strategies that minimize risk subject to meeting the business owner's profit, stability and growth objectives. The Capital Asset Pricing Model (CAPM) is one methodology the is extensively used to understand, manage and control risk in financial markets. An adaptation of the CAPM concept, using the Single Index Model (SIM), might provide new insights into development of a simple-to-understand (and implement) risk management strategy for agriculture. A weighted average of the beta coefficients, which measures the level of risk of the asset relative to the market of the assets under consideration, can be used to formulate an efficient portfolio that meets the return preference/risk avoidance objectives of an investor. An efficient portfolio, especially as defined by the SML, fairly compensates the investor for accepting risk; it contains no excess or uncompensated risk.