The Beta Coefficient is a way for investors to assess the risk of an asset compared to that of the benchmark index. The Beta coefficient is often used by the CAPM or Captial Asset Pricing Model to establish asset risk when contrasted with the border market.
To calculate the Beta Coefficient one must divide the covariance of an asset’s returns with the market returns by the variance of the market return.
Points of Regression
When the beta coefficient is found, investors can interpret the data to outline indicators of an asset’s returns when compared to that of the whole market.
Called “points of regression,” these indicators are a key function of the beta coefficient in general as they indicate whether or not an asset is moving with the border market. The Beta coefficient is not an indicator of an asset’s profits or losses, but whether or not it is moving with the overall market trends, which can lead to more informed investment decisions.
Investors can interpret the data found through the beta coefficient in relation to that of the broader market in a variety of different ways. For example, if an asset is found to deviate little from the market’s trends it is unlikely to surprise an investor, but conversely, it is also unlikely to incur any large profits, as its coherence with the market prevents such gains.
Systematic vs Unsystematic Risk
When attempting to interpret risk, the R2 formula is used. This formula is also sometimes called the ‘coefficient of determination.’ This formula can be used to describe price movements concerning that of the benchmark index.
In simple terms, when coupled with the beta coefficient the R2 number can be used to interpret the risk associated with an asset with that of the broader market. This is sometimes referred to as systematic risk.
Systematic risk is a potential for value variance that is inbuilt into the overall market system. What this means is that the risk associated isn’t expressly to do with the specifics of an asset, but is more so to do with that of the very mechanical nature of the market in general. Trends and forces that impacted all securities and assets contained with the system itself.
Unsystematic risk however is related to the specifics of an asset. This can refer to the risks brought on by specific changes to things associated with that specific asset. This can mean an event that alters the reputation of a company or figurehead. Changes in leadership, scandal or corporate error may create value risks that are specific to that asset and not necessarily that of the broader market.