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Measuring The Beta Using Historical Stock Prices
Measuring The Beta Using Historical Stock Prices
2039
The beta coefficient The linear regression approach to beta measurement using historical return data
Normalizing the data Normalized holding period returns Running the regression using MS Excel Relevant regression statistics and their interpretation Different regression charts
Under the theory of the Capital Asset Pricing Model total risk is partitioned into two parts:
Systematic Risk
Unsystematic Risk
Systematic risk is the only relevant risk to the diversified investor The beta coefficient measures systematic risk
What does the term relevant risk mean in the context of the CAPM? It is generally assumed that all investors are wealth maximizing risk averse people It is also assumed that the markets where these people trade are highly efficient In a highly efficient market, the prices of all the securities adjust instantly to cause the expected return of the investment to equal the required return When E(r) = R(r) then the market price of the stock equals its inherent worth (intrinsic value) In this perfect world, the R(r) then will justly and appropriately compensate the investor only for the risk that they perceive as relevanthence investors are only rewarded for systematic riskrisk that can be diversified away ISand prices and returns reflect ONLY systematic risk.
Each investor varies in the percentage of total risk that is systematic Some stocks have virtually no systematic risk.
Such stocks are not influenced by the health of the economy in generaltheir financial results are predominantly influenced by company-specific factors An example is cigarette companiespeople consume cigarettes because they are addictedso it doesnt matter whether the economy is healthy or notthey just continue to smoke
Some stocks have a high proportion of their total risk that is systematic
Returns on these stocks are strongly influenced by the health of the economy Durable goods manufacturers tend to have a high degree of systematic risk
Returns on Stock
Characteristic Line
The characteristic line is a regression line that represents the relationship between the returns on the stock and the returns on the market over a period of time. The slope of the Characteristic Line is the Beta Coefficient The degree to which the characteristic line explains the variability in the dependent variable (returns on the stock) is measured by the coefficient of determination. (also known as the R2 (r-squared or coefficient of determination)). If the coefficient of determination equals 1.00, this would mean that all of the points of observation would lie on the line. This would mean that the characteristic line would explain 100% of the variability of the dependent variable. The alpha is the vertical intercept of the regression (characteristic line). Many stock analysts search out stocks with high alphas.
Beta is irrelevant
High R2
An R2 that approaches 1.00 (or 100%) indicates that the characteristic (regression) line explains virtually all of the variability in the dependent variable. This means that virtually of the risk of the security is systematic. This also means that the regression model has a strong predictive ability. if you can predict what the market will dothen you can predict the returns on the stock itself with a great deal of accuracy.
(high R2)
Positive alpha R-square is very high
Diversifiable Risk
(non-systematic risk)
a single company strike a spectacular innovation discovered through the companys R&D program equipment failure for that one company management competence or management incompetence for that particular firm a jet carrying the senior management team of the firm crashes the patented formula for a new drug discovered by the firm.
Obviously, diversifiable risk is that unique factor that influences only the one firm.
OK lets go back and look at raw data gathering and data normalization
A common source for stock of information is Yahoo.com You will also need to go to the library a use the TSE Review (a monthly periodical) You want data for at least 30 months. For each month you will need:
Ending stock price Number of shares outstanding for the stock Dividend per share paid during the month for the stock Ending value of the market indicator series you plan to use (ie. TSE 300 composite index)
Go to http://ca.finance.yahoo.com Use the symbol lookup function to search for the company you are interested in studying Use the historical quotes buttonand get 30 months of historical data Use the download in spreadsheet format feature to save the data to your harddrive
Opening price per share, the highest price per share during the month, the lowest price per share achieved during the month and the closing price per share at the end of the month
Volume of trading done in the stock on the TSE in the month in numbers of board lots
Number of shares doubled and share price fell in half this is indicative of a 2 for 1 stock split.
The adjustment factor is just the value in the issued capital cell dividend by 321,400,589.
HPR
(P 1P 0 ) D1 P0
Use $59.22 as the ending price, $57.90 as the beginning price and during the month of May, no dividend was declared.
Now Put the data from the S&P/TSX Total Return Composite Index in
Normalized Normalized Stock Price Dividend $59.22 $0.00 $57.90 $0.15 $63.03 $0.00 $64.86 $0.00 $61.85 $0.15 $50.26 $0.00
You will find the Total Return S&P/TSX Composite Index values in TSE Review found in the library.
Normalized Normalized Stock Price Dividend $59.22 $0.00 $57.90 $0.15 $63.03 $0.00 $64.86 $0.00 $61.85 $0.15 $50.26 $0.00
Ending TSX HPR on Value the TSX 16911.33 0.05% 16903.36 -2.34% 17308.41 3.02% 16801.82 -0.63% 16908.11 0.16% 16881.75
Again, you simply use the HPR formula using the ending values for the total return composite index.
Regression In Excel
If you havent alreadygo to the tools menudown to add-ins and check off the VBA Analysis Pac When you go back to the tools menu, you should now find the Data Analysis bar, under that find regression, define your dependent and independent variable ranges, your output range and run the regression.
Now Use the Regression Function in Excel to regress the returns of the stock against the returns of the market
SUMMARY OUTPUT Regression Statistics Multiple R 0.05300947 R Square 0.00281 Adjusted R Square -0.2464875 Standard Error 5.79609628 Observations 6 ANOVA df Regression Residual Total SS MS 1 0.3786694 0.37866937 4 134.37893 33.5947321 5 134.7576 F Significance F 0.011271689 0.920560274
Intercept X Variable 1
Upper 95% Lower 95.0%Upper 95.0% 67.38836984 51.2957934 67.38837 96.46332302 -89.3577443 96.46332
Beta
Alpha
You can use the charting feature in Excel to create a scatter plot of the points and to put a line of best fit (the characteristic line) through the points. Finally, you will want to interpret the Beta (Xcoefficient) the alpha (vertical intercept) and the coefficient of determination.
The Beta
Obviously the beta (X-coefficient) can simply be read from the regression output. You will want to interpret it in the context of the firms, its products and the likely relationship that they hold with the health of the overall market.