 |
| Image: Moneybestpal.com |
A measure of an investment's volatility in relation to the market as a whole is called beta. It is frequently used in finance as a gauge of an investment's systemic risk. Systematic risk is the kind of risk that has an impact on the entire market and cannot be mitigated by diversifying a portfolio. Beta, then, gauges how sensitive the returns on an investment are to changes in the returns of the entire market.
When the beta value is 1, an investment's returns follow the market; when the beta value is greater than 1, an investment's returns are more volatile than the market; and when the beta value is lower than 1, an investment's returns are less volatile than the market. If a stock, for instance, has a beta of 1.5, it is 50% more volatile than the market as a whole.
The widely-used theoretical model known as the Capital Asset Pricing Model (CAPM), which explains the link between risk and expected return, relies heavily on beta as a crucial component. According to the CAPM, an investment's expected return should be proportional to its beta, which is used as a measure of a security's systematic risk.
In reality, investors who want to weigh the risks of various investments and make wise investing decisions often find beta to be a helpful tool. Beta has a number of limitations, including the fact that it only accounts for systematic risk and ignores unsystematic risk. It is crucial to remember that beta is not a perfect measure of risk and that it has these limitations. Beta projections may also be impacted by measurement error and evolve over time in response to shifting market conditions.
