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Beta Coefficient

Beta is a measure of a stock's volatility in relation to the overall market. It is calculated using regression analysis and is a key parameter in the Capital Asset Pricing Model. Beta measures how much a stock's returns fluctuate with the market - a beta of 1 means the stock moves with the market, while above 1 means it is more volatile and below 1 means it is less volatile. Beta is used to evaluate fund manager performance by distinguishing returns due to market movements (beta) versus returns from outperforming the market (alpha).

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120 views2 pages

Beta Coefficient

Beta is a measure of a stock's volatility in relation to the overall market. It is calculated using regression analysis and is a key parameter in the Capital Asset Pricing Model. Beta measures how much a stock's returns fluctuate with the market - a beta of 1 means the stock moves with the market, while above 1 means it is more volatile and below 1 means it is less volatile. Beta is used to evaluate fund manager performance by distinguishing returns due to market movements (beta) versus returns from outperforming the market (alpha).

Uploaded by

Nahidul Islam IU
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Definition of 'Beta'

The Beta coefficient (), in terms of finance and investing, is a measure of a stock's (or
portfolio's) volatility in relation to the rest of the market. Beta is calculated for individual
companies using regression analysis.
The beta coefficient is a key parameter in the capital asset pricing model (or CAPM).
It measures the part of the asset's statistical variance that cannot be mitigated by the
diversification provided by the portfolio of many risky assets, because it is correlated with
the return of the other assets that are in the portfolio.

Interpretations of Beta
Some interpretations of beta are explained in the following table:
Value of
Beta
<0
=0
0<<1

=1

>1

Interpretation
Asset generally moves in the
opposite direction as compared to
the index
Movement of the asset is
uncorrelated with the movement of
the benchmark
Movement of the asset is generally
in the same direction as, but less than
the movement of the benchmark

Example
An inverse exchange-traded fund or a
short position
Fixed-yield asset, whose growth is
unrelated to the movement of the stock
market
Stable, "staple" stock such as a
company that makes soap. Moves in
the same direction as the market at
large, but less susceptible to day-today fluctuation.
A representative stock or a stock that is
a strong contributor to the index itself.

Movement of the asset is generally


in the same direction as, and about
the same amount as the movement of
the benchmark
Movement of the asset is generally
Stocks which are very strongly
in the same direction as, but more
influenced by day-to-day market news
than the movement of the benchmark or by the general health of the
economy.

It measures the part of the asset's statistical variance that cannot be removed by
the diversification provided by the portfolio of many risky assets, because of
the correlation of its returns with the returns of the other assets that are in the portfolio. Beta
can be estimated for individual companies using regression analysis against a stock market
index.

There are several misconceptions about beta. Amongst the most common are:

Beta measures the relative volatility of a security's price compared to the price of
the market. Beta is a measure that compares returns, not prices; a security with a
positive beta can have a price that decreases while the market's price increases. The key is
whether the security's returns are above or below its mean return when the market's
returns are above or below its mean return; whether the security's mean return is positive
or negative is not relevant to its beta.

Beta measures the relative volatility of a security's returns compared to the


volatility of the market's returns. Beta has two components: relative volatility of
returns, and correlation of returns. Unless the correlation of returns is +1.0 or -1.0, beta
does not measure the relative volatilities of returns.

A positive beta means that a security's returns and the market's returns tend to
be positive and negative together; a negative beta means that when the market's
return is positive the security's return tends to be negative, and vice versa. The
calculation of beta involves deviations of the market's returns and the security's returns
about their respective mean returns. A security with a negative mean return can have a
positive beta, and a security with a positive mean return can have a negative beta.

A beta of 1.0 means that the security's returns have the same volatility as the
market's returns. This could be true, or the security's returns could be twice as volatile
as the market's returns, but their correlation of returns is +0.5. Beta, by itself, does not
describe the relative volatility of returns.

Applications of Beta
Beta is a commonly used tool for evaluating the performance of a fund manager. Beta is used
in contrast with Alpha to denote which portion of the fund's returns are a result of simply
riding swings in the overall market, and which portion of the funds returns are a result of
truly outperforming the market in the long term. For example, it is relatively easy for a fund
manager to create a fund that would go up twice as much as the S&P 500 when the S&P rose
in value, but go down twice as much as the S&P when the S&P's price fell - but such a fund
would be considered to have pure Beta, and no alpha. A fund manager who is producing
Alpha would have a fund that outperformed the S&P 500 in both good times and bad.

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