Beta (β) is a measure of the volatility-or systematic risk-of a security or portfolio compared to the market as a whole (usually the S&P 500). For beta to provide any useful insight, the market that is used as a benchmark should be related to the stock.
Beta is used in the capital asset pricing model (CAPM), which describes the relationship between systematic risk and expected return for assets (usually stocks). CAPM is widely used as a method for pricing risky securities and for generating estimates of the expected returns of assets, considering both the risk of those assets and the cost of capital.
Beta effectively describes the activity of a security's returns as it responds to swings in the market. A security's beta is calculated by dividing the product of the covariance of the security's returns and the market's returns by the variance of the market's returns over a specified period.
Beta coefficient(β) = Covariance(Re,Rm) / Variance(Rm)
where:
Re = the return on an individual stock
Rm = the return on the overall market
Covariance = how changes in a stock’s returns are related to changes in the market’s returns
Variance = how far the market’s data points spread out from their average value
Source: Investopedia, Beta: Definition, Calculation, and Explanation for Investors, accessed 25 December 2023, <https://www.investopedia.com/terms/b/beta.asp>
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