Beta is a
risk metric employed
primarily in the equity markets. It measures the
systematic risk of a
single instrument or an entire portfolio. William Sharpe (1964)
first used the notion in his landmark paper introducing the
pricing model (CAPM). The name "beta" was applied later.
Beta describes the sensitivity of an instrument or portfolio to broad
market movements. The stock market (represented by an index such as the
S&P 500 or FT-100) is assigned a beta of 1.0. By comparison, a portfolio
which has a beta of 0.5 will tend to participate in broad market moves,
but only half as much as the market overall. A portfolio (or instrument) with a beta of
2.0 will tend to benefit or suffer from broad market moves twice as much
as the market overall.
The formula for beta is.
covariance between the portfolio (or instrument)
return and the market
is the variance of the market's return (volatility squared).
Both quantities are calculated using simple returns. Beta is generally estimated from historical price
time series. For
example, 60 trading days of simple returns might be used with sample
estimators for covariance and
It is possible to construct negative beta portfolios. Approaches
stocks (such as gold mining stocks) that tend to move against the market,
shorting stocks, or
putting on suitable
Beta is sometimes used as a metric of a portfolio's
market risk. This can be
misleading because beta does not capture
specific risk. Because of
specific risk, a portfolio can have a low beta but still be highly volatile. Its price fluctuations will simply have a low
those of the overall market.