V.3:2 (72-73): Stock Beta Coefficient by Scott S. Silver & Gary M. Wingens

Stock Beta Coefficient by Scott S. Silver & Gary M. Wingens

Over the course of the past two decades the investment community has become increasingly concerned with the notion of risk and its relationship to a portfolio of assets. Economists and statisticians alike have responded to this concern with a slew of theories and formulae which have attempted to characterize market forces. One of the most widely accepted of these theories is the concept of beta and its relationship to the valuation of portfolio risk.

Essentially, beta is a comparison between the movements of an individual stock or portfolio of stocks and the movements of the market as a whole. More technically, it is a measure of the market, or nondiversifiable, risk associated with any given security in the market.

Financial theory suggests that each security's total risk is composed of two elements — the diversifiable and the nondiversifiable. Diversifiable risk is simply that portion of a security's total risk which is unique to the specific firm. This type of risk can be easily eliminated by adding additional securities to a portfolio — it can be literally diversified away. The risk which is left after diversification is aptly named nondiversifiable and can be thought of as market risk. For example, while events such as mineral discoveries, labor disputes or executive corruption are firm specific and will only effect the performance of a few securities, wars or global depressions tend to be economy-wide and will impact on every sector. Beta simply measures the expected impact of economy-wide events on specific securities.