beta and correlation

The Capital Asset Pricing Model is a model that describes the relationship between risk and expected return. Some have challenged this idea, claiming that the data show little relation between beta and potential reward, or even that lower-beta stocks are both less risky and more profitable (contradicting CAPM).Suppose an investor has all his money in an asset class X and wishes to move a small amount to an asset class Y. 0000002761 00000 n The term is used in many related ways in finance. The table shows that stock A goes down half as much as the market when the market goes down and up twice as much as the market when the market goes up. <

Therefore, knowledge of the correlation is important in determining the usefulness of the beta value.

By calculating and comparing betas, investors can determine their optimal High-beta stocks tend to be riskier but provide the potential for higher returns; low-beta stocks pose less risk but typically yield lower returns. Beta is a measure of the volatility, or systematic risk, of a security or portfolio in comparison to the market as a whole. The y-intercept is the alpha. 0000005867 00000 n Beta is a measure of the volatility , or systematic risk , of a security or a portfolio in comparison to the market as a whole.

However, those same stocks won't rise as much as the overall market during upswings. 107 0 obj Beta coefficient is a measure of sensitivity of a company's stock price to movement in the broad market index. Beta value measures a stock's correlated volatility compared to the market as a whole. 0000001559 00000 n This assumes that variance is an accurate measure of risk, which is usually good. If you think of risk as the possibility of a stock losing its value, beta has appeal as a proxy for risk. We must also know the variance of the market return. The formula for calculating beta is the covariance of the return of an asset with the return of the Beta is a measure of a fund or asset's sensitivity to the correlated moves of a benchmark. 107 28 Total beta is equal to the identity: beta/Some interpretations of beta are explained in the following table:Beta is always measured in respect to some benchmark. 0000016163 00000 n Beta is the slope, correlation is the strength of the linear relationship, and R2 is how well does the slope fit. A stock's price variability is important to consider when assessing risk. There are few fundamental investments with consistent and significant negative betas, but some Beta is important because it measures the risk of an investment that cannot be reduced by The definition above covers only theoretical beta.

For example, the betas commonly quoted in Beta decay refers to the tendency for a company with a high beta coefficient (β > 1) to have its beta coefficient decline to the market beta. 0000018839 00000 n However, the beta does need to be computed with respect to what the investor currently owns. The Peason's correlation coefficient between age and total cholesterol is 0.36. 0000002518 00000 n 0000009240 00000 n A stock that swings more than the market over time has a beta greater than 1.0. 0000000016 00000 n Based on data over the past five years, the correlation between AAPL, and SPY is 0.83.

0000007814 00000 n However, what most people are interested in is From this, we find that beta can be explained as "correlated relative volatility". AAPL has a standard deviation of returns of 23.42% and SPY has a standard deviation of returns of 32.21%. 0000013514 00000 n For a given asset and a benchmark, the goal is to find an approximate formula Beta values are not bounded like the correlation coefficient. In a single variable condition such as a CAPM beta (which is what most people are referring to), the beta is meaningless if the correlation/R2 (which are just squares/square-roots of each other under the CAPM-single-variable measurement) is low. However, according to the "Beta coefficient" redirects here. Then one uses standard formulas from linear regression. The CBOE Volatility Index, or VIX, is an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility.

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