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Investors always want great returns with minimal risk. One way that stock analysts measure risk is by looking at what's known as beta values, with higher betas representing more volatile stocks.
This is an example of a stock market anomaly since it contradicts the central prediction of many financial theories that higher returns can only be achieved by taking more risk. The capital asset pricing model (CAPM) predicts a positive and linear relation between the systematic risk exposure of a security (its beta) and its expected future return.
A beta below 1 can indicate either an investment with lower volatility than the market, or a volatile investment whose price movements are not highly correlated with the market. An example of the first is a treasury bill: the price does not go up or down a lot, so it has a low beta. An example of the second is gold. The price of gold does go up ...
For example, if a stock increased by 5% because of some news that affected the stock price, but the average market only increased by 3% and the stock has a beta of 1, then the abnormal return was 2% (5% - 3% = 2%). If the market average performs better (after adjusting for beta) than the individual stock, then the abnormal return will be negative.
Beta allows for a good comparison between an individual stock and a market-tracking index fund, but it doesn’t offer a complete portrait of a stock’s risk. Instead, it’s a look at its level ...
In investing, downside beta is the beta that measures a stock's association with the overall stock market only on days when the market’s return is negative. Downside beta was first proposed by Roy 1952 [ 1 ] and then popularized in an investment book by Markowitz (1959) .
Beta is the hedge ratio of an investment with respect to the stock market. For example, to hedge out the market-risk of a stock with a market beta of 2.0, an investor would short $2,000 in the stock market for every $1,000 invested in the stock. Thus insured, movements of the overall stock market no longer influence the combined position on ...
A riskier stock will have a higher beta and will be discounted at a higher rate; less sensitive stocks will have lower betas and be discounted at a lower rate. In theory, an asset is correctly priced when its observed price is the same as its value calculated using the CAPM derived discount rate.