Module II· Cost of Equity & CAPMIntermediate
Question
What does beta (β) measure, and how is it estimated?
Answer
Mechanics
Beta measures the systematic volatility of a stock relative to the market:
- β = 1: moves with the market.
- β > 1: swings more (tech, cyclical).
- β < 1: swings less (utilities, defensive).
Estimation
Linear regression of the stock's returns against market returns. Standard window: 5 years of weekly data or 2 years of daily data. The market index is typically a broad benchmark — the S&P 500, a mid-cap index, or the STOXX Europe 600.
Bloomberg standard
raw beta plus 'adjusted beta' (Blume: 0.67 × raw + 0.33 × 1) — the adjustment is standard in IB.