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Stock Beta
How do you interpret a stock's beta in the context of the Capital Asset Pricing Model (CAPM)?
Solution
In CAPM, a stock's beta measures its volatility relative to the overall market. A stock's beta in CAPM is determined by comparing its historical returns to the market's historical returns, typically calculated through regression analysis. A beta greater than 1 indicates that the stock is more volatile than the market, implying higher risk and potentially higher returns. A beta less than 1 means the stock is less volatile, with lower risk and potentially lower returns. A beta around 1 suggests the stock's volatility is similar to the market. Interpreting beta helps investors understand a stock's risk profile in relation to market movements, guiding investment decisions within the context of their risk tolerance.
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