Measures an investment’s volatility compared to the market. Also referred to as the “beta coefficient”..
Beta indicates the sensitivity of a stock’s or a portfolio’s rate of return compared to the rate of return on the market as a whole. A beta higher than 1 indicates higher price volatility than that of the market, and a beta below 1 would indicate lower price volatility than that of the market. A beta of 1.5 shows that returns on that asset will change by 1.5 percent for every 1 percent change in the returns on the market.
The beta coefficient is an important element in the Capital Asset Pricing Model (CAPM), which uses volatility and risk to forecast returns. According to CAPM, the beta is a type of systemic risk that cannot be eliminated through diversification.
Several considerations concerning beta coefficients must be underlined: they change over time; they are influenced by the direction of a market; if the assets are not frequently traded, the beta may not be accurate; and, finally, that the beta is not a full risk measure.
Some economists warn that the beta is a measure of “comovement” (correlated movement of two or more entities, i.e. shares and market), not of volatility, saying that there is the possibility of a 0 beta share having higher volatility than the market, although, according to its beta, that should not happen. A beta lower than one usually indicates stability, while a beta greater than 1 indicates higher potential earnings, but also higher risks..
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