Beta

The Beta (β) of a stock portfolio is a number that describes the relation of its returns with those of the stock market as a whole. Beta is also referred to as correlated relative volatility or financial elasticity

Beta

The Beta (β) of a stock portfolio is a number that describes the relation of its returns with those of the stock market as a whole. Beta is also referred to as correlated relative volatility or financial elasticity, and can be referred to as a measure of the sensitivity of the stock's returns to market returns, its non-diversifiable risk, its systematic risk, or market risk.

In fund management, measuring beta is thought to separate a manager's skill from his or her willingness to take risk. On an individual asset level, Beta can give clues to volatility and liquidity in the marketplace.


Beta Calculation

The beta coefficient was born out of linear regression analysis. It is linked to a regression analysis of the returns of a stock index (x-axis) in a specific period versus the returns of an individual stock (y-axis).

          Stock Return = Alpha + Beta * Index Return

                                   OR

          Beta (Stock Return - Alpha) / Index Return

Chart illustrating determination of Beta

Application of Beta

If Beta is less than zero then the investment's returns generally move opposite the market's returns: one will tend to be above its average when the other is below its average.   If Beta is zero then the investment has returns that change independently of changes in the market's returns.

If Beta is greater than zero then the investment's returns generally follow the market's returns, in the sense that they both tend to be above their respective averages together, or both tend to be below their respective averages together. 

The beta coefficient is a key parameter in the Capital Asset Pricing Model (CAPM). It measures the part of the portfolio's statistical variance that cannot be removed by the diversification provided by many risky stocks, because of the correlation of its returns with the returns of the other stocks within the portfolio.

Beta can be estimated for individual companies using regression analysis against a stock market index.

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