![]() ![]() The S&P 500 – the most widely used index for beta estimation for US companies – includes only 500 of the thousands of equities that are traded in the US market. Instead, the equity market indices and fixed income market indices include only a subset of the securities in each market and are not comprehensive. In actual practice, there are no indices that come close to the market portfolio. The asset is expected to generate at least the risk-free rate of return.Beta represents the slope of the line of best fit.Return of the Asset = Average Market Return If the beta of an individual portfolio is 1, then:.The expected return is calculated as:Įxpected Return = Risk-free Rate + (Beta * Market Risk Premium) ![]() It concludes that the optimally diversified portfolio includes every traded asset in the market, and the risk of an investment is the risk added on to a diversified portfolio. The model describes individual stock returns as a function of the overall market returns and assumes zero transaction costs. ![]() A positive covariance indicates that the returns move in the same direction, while a negative covariance indicates that they move inversely. ![]() The Capital Asset Pricing Model (CAPM) outlines the relationship between the expected return for assets and systematic risk – measured by the covariance of an investment’s return with the returns of the market. Low-beta stocks are less risky and fetch lower returns than high-beta stocks.īeta = Variance / Covariance Capital Asset Pricing Model (CAPM) A stock that moves more than the market shows a beta more than 1.0, and a stock that moves less than the market demonstrates a beta less than 1.0. It measures the risk added on to a diversified portfolio and is centered around one. It is estimated by regressing the returns on any asset against returns on an index representing the market portfolio, over a reasonable period.
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