RUTGERS - THE STATE UNIVERSITY OF NEW JERSEY
Beta for Stock Market Risk:
One measure of the risk or volatility of an individual stock is the standard deviation of the total return (capital appreciation plus dividends) over several periods of time. Al though the standard deviation is easy to compute, it does not take into account the extent to which the price of a given stock varies as a function of a standard market index, such as S&P 500. As a result, many financial analysts prefer to use another measure of risk referred to as Beta.
Betas for individual stocks are determined by simple linear regression. The dependent variable is the total return for the stock and the independent variable is the total return for the stock market. For this case problem, we will use the S&P 500 index as the measure of the total return for the stock market, and an estimated regression equation will be developed using monthly data. The Beta for the stock is the slope of the estimated regression equation (b1 ). The data contained in the file named "Beta.xle" provides the total
return (capital appreciation plus dividends) over 36 months for eight widely traded common stocks and the S&P 500 as well.
The value of Beta for the stock market will always be 1; thus, stocks that tend to rise and fall with the stock market will also have a beta close to 1. Betas greater than 1 indicate that the stock is more volatile than the market, and betas less than 1 indicate that the stock is less volatile than the market. For instance, if a stock has be beta of 1.5, it is 50% more volatile than the market, and if a stock has a beta of 0.5, it is 50% less volatile than the market.
Managerial report:
You have been assigned to analyze the risk characteristics of these stocks. Prepare a report that includes the following items.
1. Compute descriptive statistics for each stock and the S&P 500. Comment on your results. Which stock are the most volatile in terms of their standard deviations?
2. Compute the value of beta for each stock. Which of these stocks would you expect to perform best in an up market? Which would you expect to hold their value best in a down market?
3. Comment on how much of the return for the individual stocks is explained by the market