Why beta coefficient of a stock is calculated?

Question

Beta measure the systematic risk on a stock. Systematic risk can't be diversified no matter what number of stocks you add to a portfolio.
My question is that if the systematic risk can't be reduced then what's the point of calculating beta (which measure the market risk)? Why I want to know the systematic risk of a stock if I can't reduce it?

Answer 1

you don't really understand what Beta is and how it is calculated.



on a daily basis there is a difference between what a stock closes today and the previous day close. Likewise there is a difference between the daily close and previous close of a an index (eg the S&P 500)



if the % change for the stock is the same as the % change of the index then the stock is tracking the index as far as performance is concerned.



but no stock tracks an index perfectly....so to calculate the Beta...one creates a "scatter chart" where data points of paired %change for the stock versus the % change of the index are plotted.



the resulting plot looks like a cloud. One then takes the slope of the best straight line through those data points and that slope is the BETA for that stock for that index.



the greater the slope (beta) the greater the response of the stock relative to the index (more risk) ... so a Beta of 2 means (in general) if the index rises 2% then the stock rises 4%...or if the index falls 1% the stock falls 2%



betas less than one mean the stock is less responsive to changes in the index (hence less risky)



One piece of information (aside from which index a calculated Beta relates to) is the r-squared value...this is part of the "best straight" line calculation result and it shows how tight the data points fit the line...an r-squared value of 1 is a perfect fit....the smaller the fraction the worse the fit.



So 2 stocks can have the best straight line but on one the r-squared value is nearer to 1 than the other....beta's of stocks with poor r-squared values are not very good to make judgements on.



You would want to know the risk of a stock when trying to choose between 2 stocks in the same sector. If you were looking for a high flyer in good times the higher the Beta the more it flies but be aware that in bad times it falls faster.



Betas are best when you calculate them yourself.....



this is a post I made on the limitations and errors associated with PUBLISHED beta values...the best beta values are those you calculate yourself...(if you want to do it)



https://answersrip.com/question/index?qid=20120826055613AAdOQAG



good luck



EDIT:



The Systemic Risk measured by Beta relates to the volatility of a stock. Systemic risk relates to how the stock reacts to events beyond its control. So when you see a stock with a high Beta there is high volatility in its reaction to market changes...whereas a stock with low Beta values the outside influence of the market has less effect. So if you are looking for stocks that are slower groth but less affected by market pressures...then lower beta stocks may be your choice.



But the issues of BETA cause more confusion then they solve IMHO as mentioned in my previous posts...PUBLISHED Betas do not indicate how they are calculated...that is why you see beta's on one website different from beta's on another.



ALSO: Is it fair to compare the beta of a mining stock to the S&P 500 which is not a mining index?? I don't think so personally but others may disagree.



The best Beta's are ones that you calculate yourself...it is not hard to set up a spreadsheet and import data of stock values and relevant indices....then calculate the daily % deviations and calculate the best straight line for the slope (beta) and r-squared (goodness of fit)....THEN you can make intelligent use of the Beta information...using published beta's are useless IMHO

Answer 2

Because you can reduce the risk of a stock portfolio.



You surely want to know Beta because, in constructing a portfolio, you can pick stocks or assets with different Beta, including negative Beta (bonds for instance), such that the resulting effect is to have a portfolio with risk-adjusted returns (measured with the Sharpe ratio, for instance) higher than the market.



That's all the story of asset allocation.

Answer 3

It is just a way of telling investors that the stock can move in greater percentages on a daily basis than the market. To say that systematic risk cannot be reduced is a false statement. Many small caps are high beta stocks, if you reduce your holdings in small caps, your risk is reduced.

Answer 4

I covered this in my MSc Investment Banking years ago but if I remember correctly it's something to do with the stocks market risk compared to the whole market.



using regression analysis anything below 1 is good and anything above 1 is bad.



Check out Investopedia or Wikipedia and they should put you on the right track.



Just steer clear of Black, Scholes, Merton option pricing model lol it will send you loopy