How is Beta (β) interpreted? (Part 2 of 4)

Beta measures how a particular financial asset or a portfolio of assets fluctuates with respect to the market.

More specifically, the Beta coefficient informs us of the historical sensitivity of a financial asset’s returns against the systematic risks relative to the historical sensitivity of market’s returns (represented by its benchmark index) to those same systematic risks.

The rule for its interpretation is that, the higher the beta in absolute terms, the more sensitive a financial asset has been than the market, to the same systematic risks. 

Let’s take a closer look:

1. Direction of movements of an asset or portfolio relative to market movements:

Positive Beta Values (Beta > 0)

Positive Beta values indicate that historical returns of an asset or portfolio of assets have moved in the same direction as the market. When the market had a positive returns performance, the returns on the asset or portfolio also had positive performance. On the contrary, when the market fell, the asset or portfolio also fell.

Systematic risks have affected that asset or portfolio in the same direction, whether positive or negative to how they have affected a particular market as a whole.

When the Beta sign is negative (Beta < 0)

Negative Beta values tell us the opposite. In this case, the historical returns on an asset or portfolio of assets have evolved in the opposite direction to market returns. When the market had a positive performance, the returns on the asset or portfolio had a negative evolution. In the opposite way, when the market fell, the asset or portfolio went up.

Systematic risks have affected that asset or portfolio in a way that is contrary to how they have affected a particular market as a whole.

2. Magnitude of the movements of an asset relative to market movements.

Beta values equal to 1 or -1. (Beta = 1 and Beta = -1)

Beta values of an asset or portfolio equal to 1 or -1, indicate that the historical returns of an asset or portfolio of assets have evolved in exactly the same magnitude as the market.

A value of Beta = 1 shows that returns on assets or portfolios have been fully correlated with the returns in the market itself (returns have moved exactly the same). 

Systematic risks have affected that asset or portfolio exactly as they have affected a particular market as a whole.

With a value of Beta = -1, asset or portfolio returns have been inversely correlated with market returns (returns have moved by exactly the same magnitude, but in the opposite direction).

Systematic market risks have affected that asset or portfolio in exactly the opposite direction as they have affected a particular market as a whole.

Beta values equal to 0 (Beta = 0)

A financial asset or portfolio of financial assets with Beta equal to zero means that their returns have not been affected by the systematic risks that have caused the market to fluctuate.

These are assets or portfolios that are not correlated with market performance.

Beta values greater than 1 or less than -1. (Beta > 1, and Beta < -1)

When the Beta value of an asset or portfolio is greater than 1, it means that when the market went up, returns on that asset or portfolio rose more than the market and when the market fell that asset or portfolio fell more than the market.

In the case of Betas below -1, when the market rose, the asset or portfolio fell more than the market rose. Conversely, when the market fell, the asset or portfolio rose higher than the market fall.

Systematic market risks have affected that asset or portfolio more than a particular market as a whole. 

Beta values greater than 0 and less than 1 (0 < Beta < 1) and Beta values less than 0 and greater than -1 (-1 < Beta < 0)

When the Beta value of an asset or portfolio is greater than 0 and less than 1, it means that when the market went up, returns on that asset or portfolio rose less than the market and when the market fell that asset or portfolio fell less than the market.

In the case of Betas greater than -1 but less than 0, when the market rose, the asset or portfolio fell less than the market rose. And, conversely, when the market fell, the asset or portfolio went up less than the market fall.

Systematic market risks affect that asset or portfolio less than a particular market as a whole.

Conclusion

In short, the Beta coefficient can be interpreted as follows:

  • If β=1: the asset is exactly as volatile as the market.
  • If β=0: the asset is not correlated with the market.
  • If β<0: the asset is negatively correlated with the market.
  • If β<-1 or β>1: the asset is more volatile than the market. 
  • If -1<β<1: the asset is less volatile than the market.

Collection of articles about Beta Coefficient (β):

  1. What is the Beta coefficient in finance?
  2. How is Beta interpreted? (current post)
  3. How to measure risks with Beta?
  4. How to estimate returns with Beta?
José Luís Álvarez – CEO HollyMontt

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