Performance Perspectives Blog

Beta, wanted dead or alive

by | Jan 12, 2010

A 1992 Journal of Finance article by Fama & French is often cited as the source for the line, “Beta is dead.”

Recall that Beta is a measure of volatility; actually, a security’s volatility vis-a-vis the market. It is used in the Capital Asset Pricing Model, for which William Sharpe received the 1990 Nobel Prize in Economics.

The formula is the covariance of security return with the market, divided by the market’s variance. The market’s beta equals 1.0; a higher beta means the security goes up faster than the market, and will also go down faster; a lower beta means the security moves won’t be as great as the market’s.Critics (and sufficient analysis) contends that beta fails as a predictor of security returns; that there are other attributes that play a bigger role. Most of the criticism has been somewhat respectful, though some, like Nassim Taleb (The Black Swan) have been a bit more forceful. Even Jack Treynor criticized its use in the aponymously named risk-adjusted measure which he disavows responsibility for.

Fama & French, as you may recall, introduced a three factor model, which includes beta, size (large cap vs. small cap) and style (growth, value). Other models have been suggested, as well.

In spite of the critics, beta remains a much calculated and reported risk measure. And why is this? Perhaps because “everyone does it.” Or, “we’ve been doing it so long, why stop?” Or, “because it’s easy to understand and interpret” (even though it’s wrong?). Beta may be dead, but it’s still around and kickin’.

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