The measure of an asset's risk
in relation to the market
(for example, the S&P500
) or to an alternative benchmark
. Roughly speaking, a security with a beta of 1.5, will have move, on average
, 1.5 times the market return
. [More precisely, that stock's excess return
(over and above a short-term
money market rate) is expected to move 1.5 times the market excess return
).] According to asset pricing theory, beta represents the type of risk, systematic risk
, that cannot be diversified
away. When using beta, there are a number of issues that you need to be aware of: (1) betas may change through time; (2) betas may be different depending on the direction of the market (i.e. betas may be greater for down moves in the market rather than up moves); (3) the estimated beta will be biased if the security does not frequently trade; (4) the beta is not necessarily a complete measure of risk (you may need multiple betas). Also, note that the beta is a measure of co-movement, not volatility
. It is possible for a security to have a zero beta and higher volatility than the market.
Beta is a measure of an investment's relative volatility. The higher the beta, the more sharply the value of the investment can be expected to fluctuate in relation to a market index.
For example, Standard & Poor's 500 Index (S&P 500) has a beta coefficient (or base) of 1. That means if the S&P 500 moves 2% in either direction, a stock with a beta of 1 would also move 2%.
Under the same market conditions, however, a stock with a beta of 1.5 would move 3% (2% increase x 1.5 beta = 0.03, or 3%). But a stock with a beta lower than 1 would be expected to be more stable in price and move less. Betas as low as 0.5 and as high as 4 are fairly common, depending on the sector and size of the company.
However, in recent years, there has been a lively debate about the validity of assigning and using a beta value as an accurate predictor of stock performance.