Final answer:
The standard deviation of a portfolio measures the total risk, including both systematic and unsystematic components, and can be less than the weighted average of the individual securities' standard deviations due to diversification. It helps in determining the risk premium required by investors.
Step-by-step explanation:
The standard deviation of a portfolio is crucial for assessing the risk and variability of returns in finance. It is not a direct measure of systematic risk, which is the risk inherent to the entire market or market segment. Instead, the standard deviation indicates the variability of a portfolio's returns around its mean, reflecting both systematic and unsystematic risk.
While one might assume that the standard deviation of a portfolio is a weighted average of the standard deviations of the individual securities it contains, diversification effects often mean the portfolio's standard deviation may be less than the weighted average. This is due because individual securities' price movements can offset each other, especially if they are not perfectly correlated. In other words, the benefits of diversification can lead to a total risk that is lower than what would be expected by simply combining the individual risks of the securities held.
Furthermore, the standard deviation of a portfolio provides us with a measure of how far the returns can deviate from the expected mean, which is essential for calculating the risk premium that investors require. The notion that the standard deviation can be less than the weighted average captures the essence of diversifiable risk, as it is the component of a portfolio's total risk that can be mitigated through diversification.