in the six years i spent at university, a term that never failed to enter discussion was that of "beta", relative to both the finance and real estate industries. While baffling many a student, the concept itself is fairly basic once you see the bigger picture. Perhaps this brief description that i wrote as part of an investment markets assignment (Msc) last year might help to lighten the load.
In finance, the term "beta" is used to represent systematic risk i.e. the risk affecting the market as a whole which is non-diversifiable. The beta of a company measures the extent to which a movement in the general market will translate into movements of the company's stock i.e. the relative volatility of a stock's returns to those of the market. This relationship is illustrated through linear regression analysis; whereby beta effectively represents the slope of a linear equation.
Stock analysts refer to beta in order to determine risk profiles of stocks in terms of price risk. By definition, the market has a beta of 1.0, and individual stocks are ranked according to how much they deviate from the market. A beta of 0 would mean that a company's stock is independent of the overall market, while a high beta (>1.0) would suggest that the stock magnifies market movements. High beta stocks are regarded as riskier investments; however, they provide the potential for higher returns. Hoesli & MacGregor (2000) suggest that in bull markets, investors tend to look for high-beta companies, while in bear markets, they look for low-beta.
Chiang, Lee & Wisen (2004) state that past price movements are very poor predictors of future events; in line with Random Walk theory and thereby the semi-strong efficient market hypothesis: "Betas are merely rear-view mirrors, reflecting little of what lies ahead". However, analysis of beta over time does give some indication of a stock's relationship to a chosen index or benchmark and consequently any tendencies to trend can be evaluated.
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