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1.
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Definition
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The Beta coefficient, in terms of
finance and investing, is a measure of a stock's (or portfolio's)
volatility in relation to the rest of the market. Beta is calculated
for individual companies using regression analysis.
The beta coefficient is a key parameter in the capital asset pricing
model (or CAPM). It measures the part of the asset's statistical
variance that cannot be mitigated by the diversification provided by
the portfolio of many risky assets, because it is correlated with
the return of the other assets that are in the portfolio.
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2.
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Examples, Types, or
Variations
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Beta < 0: Negative Beta - not likely.
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Beta = 0: Cash in the bank.
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Beta Between 0 and 1: Low-volatility
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Beta = 1: Matching the market.
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Beta > 1: More volatile than the market.
Example of use: A fund with a
beta of 1 is deemed to have the same volatility as the S&P 500;
therefore a fund with a beta of 4 is four times more volatile than
the S&P 500, and a fund with a beta of .25 is 25% as volatile as the
S&P 500.
This means that a fund with a beta of 4 would rise 40% if the
S&P 500 rose 10% (the same is true of a drop).
The three basic interpretations of Beta are as follows:
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Econometric Beta: The primary
risk factor for the CAPM. Relevant to pricing and not valuation.
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Graphical Beta: The slope
coefficient of the characteristic line.
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Statistical Beta: The measure of
systematic risk in the CAPM.
Beta is
also referred to as financial elasticity or correlated relative
volatility, and can be referred to as a measure of the asset's
sensitivity of the asset's returns to market returns, its
non-diversifiable risk, its systematic risk or market risk. On an
individual asset level, measuring beta can give clues to volatility
and liquidity in the marketplace. On a portfolio level, measuring
beta is thought to separate a manager's skill from his or her
willingness to take risk.
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3.
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Formula
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The
Formula for Beta is: |
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beta= |
[
Cov(r, Km) ] / [
StdDev(Km) ]2
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Where:
r is the return
rate of the investment;
Km is the return rate of the asset class.
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4.
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Related Terms
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Alpha
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Modern Portfolio Theory
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Capital Asset Pricing Model (CAPM)
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CML
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Systematic Risk
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Volatility
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Weighted Average Cost of Capital (WACC)
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Coefficient
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High
Beta Index
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Zero
Beta Portfolio
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5.
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As
Used in the Hedge Fund World
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Beta,
along with Alpha, account for 70-80% of the overall hedge fund
returns.
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6.
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Applications
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Common
Applications of Beta include:
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Balanced Funds
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Zero Beta Portfolio
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High Beta Index
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CAPM
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Nova/Ursa Ratio
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Treynor Ratio
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7.
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Misused
& Abused
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The beta
movement should be distinguished from the actual returns of the
stocks. For example, a sector may be performing well and may have
good prospects, but the fact that its movement does not correlate
well with the broader market index may decrease its beta. However,
it should not be taken as a reflection on the overall attractiveness
or the loss of it for the sector, or stock as the case may be. Beta
is a measure of risk and not to be confused with the attractiveness
of the investment.
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8.
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Additional Sources of Information
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Books
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News
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Scholarly Papers
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Back to Terms
| HEDGE FUND RISK AND OTHER
DISCLOSURES |
Hedge funds, including fund of funds (“Hedge
Funds”), are unregistered private investment partnerships, funds or
pools that may invest and trade in many different markets,
strategies and instruments (including securities, non-securities and
derivatives) and are NOT subject to the same regulatory requirements
as mutual funds, including mutual fund requirements to provide
certain periodic and standardized pricing and valuation information
to investors. There are substantial risks in investing in Hedge
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carefully note the following:
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ability, sophistication/experience and willingness to bear the
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set aside strictly for speculative purposes.
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performance and may use hypothetical or pro forma performance
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place undue reliance on hypothetical or pro forma performance.
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generally charged at the fund as well as the sub-fund levels;
therefore fees charged investors will be higher that those charged
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of the investor’s investment objectives, financial circumstances and
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