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, 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).
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.
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This glossary post was last updated: 26th March, 2020