Beta Coefficient

Overview of Beta Coefficient
The Beta Coefficient is an important term in the context of investment as well as finance. It is used for measuring the volatility of a stock in the context of the remaining stock market. The Beta Coefficient is also employed by individual companies that use regression analysis.

The Beta Coefficient is also described as follows:

  • Financial Elasticity
  • Correlated Relative Volatility

Importance of Beta Coefficient
The Beta Coefficient is an extremely important term in the context of the Capital Asset Pricing Model. In the Capital Asset Pricing Model, the Beta Coefficient is used to measure a certain part of the statistical variance of an asset.

This part is not supposed to be relieved by the diversification of a portfolio that has a number of assets that are risky. The main reason as to why the particular part being measured by the Beta Coefficient cannot be mitigated by portfolio diversification is the fact that particular part has a correlation with the returns that are being provided by the other assets that are present in the same portfolio.

The Beta Coefficient is helpful at the following levels:
a) Individual Asset Level
Provides clues to volatility in the markets Gives hints regarding liquidity in the markets
b) Portfolio Level
Differentiates the skill levels of a particular investment manager from that individual’s propensity to make risky business decisions
Equational Representation of Beta Coefficient
The Beta Coefficient is represented by the following numerical presentation:

ßa = Cov(ra, rp) / Var(rp) In this formula:

ra is used to determine the rate at which the returns are provided by the asset
Cov(ra, rp) happens to be the covariance of the rate of return of the asset and the rate of return of the portfolio
rp is used in order to find out the rate of return for the particular portfolio that contains the asset

However, in the Capital Asset Pricing Model it is assumed that the portfolio is actually the market portfolio and it has all the risky assets. Thus the rp of the formula is substituted by rm, which is the return rate of the market.

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Last Updated on : 1st July 2013

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