Beta Flashcards
(14 cards)
Formula for Beta
Alternative Beta Formula
What does beta tell you ?
It quantifies the systematic risk (market-related risk) of an asset:
How sensitive the asset is to market movements
How it contributes to the volatility of a diversified portfolio
Beta = 1
Asset moves in line with the market.
If market goes up 1%, asset goes up 1% (on average).
Systematic risk = equal to market risk.
Fully exposed to market movements.
Beta > 1
Asset is more volatile than the market.
If market rises 1%, asset rises more than 1% (and vice versa).
High systematic risk.
Beta < 1
Asset moves with the market, but less strongly.
Lower systematic risk.
Beta = 0
No correlation with market movements.
Purely idiosyncratic risk.
Return is independent of market โ zero systematic risk.
Systematic vs Unsytematic Risk
Be sure do know the difference between Variance and Std Deviation
I have to split the variance into sys risk to calculate beta
Sys vs unsy risk formula and variance
Interpretation of a 0.874 Correlation
So higher ๐๐,๐โ increases ๐ฝ๐ , thereby increasing systematic variance.
Thus, if ๐แตข,แดน > 0.9:
This indicates a beta closer to 1 or above (assuming similar volatilities),
Resulting in high sensitivity to market movements,
And thus, high systematic variance.
Q: What does ๐แตข,แดน = 0 mean?
A: No linear relationship between firmโs returns and market returns.
โ Systematic risk = 0.
โ All risk is idiosyncratic.
โ Beta = 0.
โ Full diversification benefit.
Q: What does ๐แตข,แดน = 0.2 mean?
A: Weak positive correlation with the market.
โ Low systematic risk.
โ Beta is low.
โ Limited but present diversification benefit.
โ Small market risk premium.
Q: What does ๐แตข,แดน = 1 mean?
A: Perfect positive correlation with the market.
โ All return variability is explained by market movements.
โ Systematic variance = total variance.
โ Beta = 1 (if volatilities equal).
โ No diversification benefit.
