Beta: A Measure of Systematic Risk
Beta is a measure of the systematic risk of a security or portfolio compared to the overall market. It gauges the tendency of the return of a security to move in parallel with the return of the stock market as a whole. Beta is calculated by dividing the covariance of the security’s returns and the market’s returns by the variance of the market’s returns over a specified period.
Key Facts
- Beta is a measure of a stock’s volatility in relation to the market.
- It gauges the tendency of the return of a security to move in parallel with the return of the stock market as a whole.
- Beta is calculated by dividing the covariance of the security’s returns and the market’s returns by the variance of the market’s returns over a specified period.
- A beta of 1 indicates that the portfolio will move in the same direction and have the same volatility as the market. It is sensitive to systematic risk.
- Systematic risk, also known as total market risk, affects stocks across many industries, sectors, and asset classes.
- Systematic risk cannot be eliminated through diversification since it affects the entire market.
- Beta can be used to assess the level of exposure to systematic risk. High betas indicate greater sensitivity to systematic risk, which can lead to more volatile price swings in a portfolio.
A beta of 1 indicates that the portfolio will move in the same direction and have the same volatility as the market. A beta greater than 1 indicates that the portfolio will move in the same direction as the market, but with greater volatility. A beta less than 1 indicates that the portfolio will move in the same direction as the market, but with less volatility.
Systematic risk, also known as total market risk, affects stocks across many industries, sectors, and asset classes. It is caused by factors that affect the entire economy, such as interest rates, inflation, and economic growth. Systematic risk cannot be eliminated through diversification since it affects the entire market.
Beta can be used to assess the level of exposure to systematic risk. High betas indicate greater sensitivity to systematic risk, which can lead to more volatile price swings in a portfolio. Investors can use beta to diversify their portfolios and reduce their exposure to systematic risk.
References
- Does the Capital Asset Pricing Model Work?
- How Beta Measures Systematic Risk
- Beta: Definition, Calculation, and Explanation for Investors
FAQs
What is beta?
Beta is a measure of the systematic risk of a security or portfolio compared to the overall market.
What is systematic risk?
Systematic risk, also known as total market risk, affects stocks across many industries, sectors, and asset classes. It is caused by factors that affect the entire economy, such as interest rates, inflation, and economic growth.
How is beta calculated?
Beta is calculated by dividing the covariance of the security’s returns and the market’s returns by the variance of the market’s returns over a specified period.
What does a beta of 1 mean?
A beta of 1 indicates that the portfolio will move in the same direction and have the same volatility as the market.
What does a beta greater than 1 mean?
A beta greater than 1 indicates that the portfolio will move in the same direction as the market, but with greater volatility.
What does a beta less than 1 mean?
A beta less than 1 indicates that the portfolio will move in the same direction as the market, but with less volatility.
Can beta be used to eliminate systematic risk?
No, beta cannot be used to eliminate systematic risk because systematic risk affects the entire market.
How can investors use beta?
Investors can use beta to assess the level of exposure to systematic risk and to diversify their portfolios.