The choice depends on the trade off between accuracy of beta measurement longer periodic measurement times and more years give more accurate results and historic firm beta changes over time for example, due to changing sales products or clients. Intuitively, one would not suggest a company with high return [e.
These estimators attempt to uncover the instant prevailing market-beta.
Beta (finance) - Wikipedia
When long-term market-betas are required, further regression toward the mean over long horizons should be considered. In the idealized capital asset pricing model CAPM , beta risk is the only kind of risk for which investors should receive an expected return higher than the risk-free rate of interest. When used within the context of the CAPM, beta becomes a measure of the appropriate expected rate of return. Due to the fact that the overall rate of return on the firm is weighted rate of return on its debt and its equity, the market-beta of the overall unlevered firm is the weighted average of the firm's debt beta often close to 0 and its levered equity beta.
In fund management, adjusting for exposure to the market separates out the component that fund managers should have received given that they had their specific exposure to the market. This is measured by the alpha in the market-model, holding beta constant.
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Occasionally, other betas than market-betas are used. The arbitrage pricing theory APT has multiple factors in its model and thus requires multiple betas.
Example of alpha in finance
The CAPM has only one risk factor , namely the overall market, and thus works only with the plain beta. For example, a beta with respect to oil-price changes would sometimes be called an "oil-beta" rather than "market-beta" to clarify the difference. Betas commonly quoted in mutual fund analyses often measure the exposure to a specific fund benchmark, rather than to the overall stock market. Such a beta would measure the risk from adding a specific fund to a holder of the mutual fund benchmark portfolio, rather than the risk of adding the fund to a portfolio of the market.
Utility stocks commonly show up as examples of low beta. These have some similarity to bonds, in that they tend to pay consistent dividends, and their prospects are not strongly dependent on economic cycles. They are still stocks, so the market price will be affected by overall stock market trends, even if this does not make sense. Foreign stocks may provide some diversification. However, this effect is not as good as it used to be; the various markets are now fairly correlated, especially the US and Western Europe.
Derivatives are examples of non-linear assets. Beta relies on a linear model. An out of the money option may have a distinctly non-linear payoff. The change in price of an option relative to the change in the price of the underlying asset for example a stock is not constant.
From Wikipedia, the free encyclopedia. For the general statistical concept, see Standardized coefficient. For other uses, see Beta disambiguation. This article needs additional citations for verification. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. This section possibly contains original research.
Please improve it by verifying the claims made and adding inline citations. For well-subscribed smart beta strategies, the magnitude of the trading shifts necessary to rebalance can be so large as to negatively impact trading efficacy, as the total size of these trades precludes getting best price and execution.
A more insidious consideration is front-running. As most smart beta strategies are defined by their systematic construction process, this trait makes them potentially subject to the predatory practices of front-runners. Ironically, the rules-based and systematic portfolio construction practices that define smart beta portfolios may be playing into the hands of opportunistic traders.
While overcrowding and front-running may not necessarily lead to underperformance, they could potentially reduce the index returns themselves. Investors may discover that they have subscribed to a vehicle that may not meet their initial expectations. Even with the above caveats, smart beta strategies provide relatively cheap exposures to various risk factors in the market, and can be used to augment a portfolio of active managers, if the overall portfolio turns out to be over- or underexposed to these factors.
More difficult is the prospect of building a portfolio of smart beta strategies. A naive reliance on historical correlations may be ill-advised. If many factors turn sour at the same time, underperformance versus a cap-weighted index could be severe and prolonged. It may be sensible to dynamically adjust exposures to different smart beta strategies over time, but this is probably no easier than determining when individual stock prices — or the market as a whole — are likely to rise or fall. How can investors be smarter about smart beta?
The answer is smart alpha. Smart alpha is a means by which investors can tap into the common return source of the most popular smart beta strategies, but in a way that is designed to make the best use of this return source in a risk-controlled and targeted framework. We have made the point that the common thread linking the various non-cap-weighted smart beta strategies described is the necessity to rebalance.
It can further be demonstrated that this very rebalancing activity is actually the principal driver of the return enhancement. Most smart beta strategies tap into this rebalancing premium accidentally, while pursuing their own particular factor exposure objective. Adrian Banner , December Can Beta Become Smarter?
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