Dr. Harvey's Financial Glossary

Thursday, March 18, 2010

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Beta: The measure of an asset's risk in relation to the market (forexample, the S&P500) or to an alternative benchmark or factors. Roughly speaking,a security with a beta of 1.5, will have move, on average, 1.5 times the market return. [Moreprecisely, that stock's excess_returns (over and above a short-term money market rate) is expected to move 1.5 times the market excess_returns).] According to asset pricing theory, beta represents thetype of risk, systematic risk, thatcannot be diversifiable_risk away. Whenusing 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 thedirection of the market (i.e. betas may be greater for down moves in the marketrather than up moves); (3) the estimated beta will be biased if the securitydoes not frequently trade; (4) the beta is not necessarily a complete measureof risk (you may need multiple betas). Also, note that the beta is a measure ofcomovement, not volatility. It is possiblefor a security to have a zero beta and higher volatility than the market.

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