Aswath Damodaran 105
Firm Specific and Market Risk
! The R squared (R^2 ) of the regression provides an estimate of the proportion
of the risk (variance) of a firm that can be attributed to market risk;
! The balance ( 1 - R^2 ) can be attributed to firm specific risk.
This ties back to the second step of the derivation of the model, where we
divided risk into diversifiable and non-diversifiable risk. R squared measures the
proportion of the risk that is not diversifiable (also called market or systematic
risk)
