Beta riskier the security’. Generally, beta is

Beta is
often recognised as a measure of risk and is gauged by using the standard deviation or variance concerning
returns from a security or market index. Universally, it is believed that ‘the greater
the volatility, the riskier the security’. Generally, beta is widely used in
the Capital Asset Pricing Model CAPM ‘which calculates the expected return of an asset based on its beta and expected market returns.’ Risk premiums are contingent on ‘investment
climate and business cycle’ and just like beta, it is not fixed giving rise to
the numerous questions on the authenticity of the beta calculations and results.
As multiple research articles have suggested and proven that beta is not an
accurate measure for risk.

 

The CAPM model is
considered to be an ‘equilibrium model’ i.e. a replica of a particular market
situation in which an investor discovers him/herself in with little to no
explanation of the rudiments like how the variables were calculated etc., because
it is priced at fair value and it seems like a ridiculous notion that the
prices move in either direction. Moving on, a market portfolio should ideally
consider all risky assets, however when the CAPM model uses beta to obtain
results, not all points are considered like monetary and dogmatic factors,
which gives light to Benjamin Graham’ theory that beta uses past stock
prices to calculate future returns which shows how unreliable it can prove to
be as a company’s future return cannot be predicted accurately based on past
figures.

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One of the main
issues with beta as Warren Buffet posed as a question was, ‘why should the
investor only focus on how assets move in relation to the market?’ and ‘should
this be their only concern?’. There are no other aspects like a company’s cash
flow, ‘earning price ratio effect, ratio effect or book to market ratio effect’
etc. that’s looked into. Every company prepares financial statements at the year
end and they have professional authorities who audit their statements, yet the
only form of risk that is considered is beta. This implies that there are other
factors that can shed light on how prices of equity fluctuate more efficiently
in comparison to beta.

Furthermore, beta is a vital aspect that is studied
while assessing the risk of a security. Nevertheless, this was eventually
opposed by Fama and French three-factor model where the idea of considering a
number of extensive variables in order to assess the risk a security emerged. Finally,
as per the CAPM assumptions, the greater beta stocks have a considerably higher
risk, hence it is believed that investors should be compensated equally.
Empirical research has demonstrated this in the course of their investigation
that low beta and high beta
stocks in contradiction to the returns produced by them for investors. Investors were shocked with the returns they actually
received by the stocks in comparison to the expected returns from CAPM. The
betas are considered relatively unpredictable as its significant stocks become pricy and
development stocks are cheaper