Business, Legal & Accounting Glossary
The beta (ß) of a stock or portfolio is a number describing the relation of its returns with that of the financial market as a whole. An asset with a beta of 0 means that its price is not at all correlated with the market. A positive beta means that the asset generally follows the market. A negative beta shows that the asset inversely follows the market; the asset generally decreases in value if the market goes up and vice versa.
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.
Beta, the second Greek letter, is used by investors to mean the volatility of any stock, mutual or hedge fund, or portfolio relative to its market. Beta, like alpha, is a risk-adjusted measure relative or benchmark. Like alpha, the beta has origins in CAPM and Modern Portfolio Theory where the market return of a portfolio is compared to a “risk-free” market rate or benchmark. Arbitrage Pricing Theory (APT), which uses multiple betas, models a corresponding beta for each APT market risk factor. Statistical software packages are available to calculate beta, and investment advisers sometimes keep a beta book where they can look up the beta of an individual stock, sector, mutual fund, or market index and compare it to the beta of a stock market index for the same period. A beta of 1.0 means a stock’s risk is the same as the S&P 500 Index, a beta of 2.0 means a stock’s risk is above the market’s. Remember: risk and return are a trade-off and low beta stocks may produce a low return as well as lower risk.
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
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.
While assessing the risk of a particular stock, its price variability is an important parameter. Beta acts as a proxy for a stock’s risk. Prior to an investment in a securities portfolio, investors normally carry out valuation analysis to determine the risk profile of their investment portfolio. Beta is also a clear and quantifiable measure, which lends itself to mathematical treatment. However, stock market investors need to keep a tab of other available stock market parameters and apply it as per the situation.
The beta was pleasing to us as we were interested in many different metrics and ratios to best understand the security.
The software company’s engineers continued their work on the complex and difficult finance software, which entered live beta testing yesterday.
Before the company can release the software, there is a testing phase called the Beta testing phase in which qualified testers will determine if the software is stable or not.
minimum-variance portfolio
unlevered beta
zero-beta portfolio
portable alpha
alpha equation
factor portfolio
portfolio beta score
modern portfolio theory
beta decay
Gordon Growth Model
Beta is a risk metric employed primarily in the equity markets. It measures the systematic risk of a single instrument or an entire portfolio. William Sharpe (1964) first used the notion in his landmark paper introducing the capital asset pricing model (CAPM). The name “beta” was applied later.
Beta describes the sensitivity of an instrument or portfolio to broad market movements. The stock market (represented by an index such as the S&P 500 or FT-100) is assigned a beta of 1.0. By comparison, a portfolio (or instrument) which has a beta of 0.5 will tend to participate in broad market moves, but only half as much as the market overall. A portfolio (or instrument) with a beta of 2.0 will tend to benefit or suffer from broad market moves twice as much as the market overall.
The formula for beta is
[1]
where
is the variance of the market’s return (volatility squared).Both quantities are calculated using simple returns. Beta is generally estimated from historical return data. For example, 60 trading days of simple returns might be used with sample estimators for covariance and variance.
It is possible to construct negative beta portfolios. Approaches include
Beta is sometimes used as a metric of a portfolio’s market risk. This can be misleading because beta does not capture specific risk. Because of specific risk, a portfolio can have a low beta but still be highly volatile. Its price fluctuations will simply have a low correlation with those of the overall market.
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This glossary post was last updated: 28th December, 2021 | 0 Views.