What is Beta and Systematic Risk?
Beta is a measure of systematic risk—the risk that cannot be eliminated through diversification because it affects the entire market. It quantifies how much an investment's price movements correlate with overall market movements.
Beta is the ratio of an investment's price movements to market movements: β = Covariance(investment return, market return) / Variance(market return). β=1 moves with market; β>1 is more volatile; β<1 is less volatile.
Step-by-step worked examples
A tech stock with β=1.3 and market rises 10%. How much does stock rise?
Stock return ≈ β × Market return Stock return ≈ 1.3 × 10% = 13% The stock is 30% more volatile than market.
Utility company stock has β=0.6. Market falls 20%. Stock decline?
Stock return ≈ 0.6 × (−20%) = −12% The stock is buffered; declines less than market.
Bond fund with β=0.4 in a 30% market crash. Loss?
Fund return ≈ 0.4 × (−30%) = −12% Fund is very defensive; preserves capital in downturns.
Flashcards
Quick quiz
Q1.Stock with β=1.2 and market up 10% → stock return approximately…
Q2.β=1 means…
Q3.Higher beta means…
Q4.Systematic risk (beta) can be eliminated by…
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Common mistakes
Thinking β=2 means double profit. — Correct: β=2 means double volatility—gains and losses 2×, not guaranteed profit.
Confusing beta with correlation. — Correct: Beta = correlation × (σ_stock / σ_market). Includes volatility ratio.
Assuming negative beta never exists. — Correct: Rare, but exists—inverse ETFs and gold sometimes have negative beta.
Thinking high beta always bad. — Correct: High beta = high risk + high potential return; depends on risk tolerance.
FAQ
What is beta?
Systematic risk coefficient; measures how investment moves with market.
How to calculate beta?
Covariance(stock return, market return) / Variance(market return).
Can beta be negative?
Rarely—means investment moves opposite to market (e.g., inverse ETFs).
Is beta complete risk measure?
No—captures systematic risk only; total risk includes unsystematic (idiosyncratic) risk.