Risk according to Beta value.

Suppose we have 3 companies namely A , B , C and have a beta of 0.8 , 0.95 , 1.0 respectively. Which among the companies A,B,C entails high risk ?

6 responses

You cannot tell from betas.

Beta = Correlation_Between_Stock_and_Market * Standard_Deviation_Stock / Standard_Deviation_Market

But people usually think risk as Standard_Deviation_Stock.

Thanks Adam for your reply but given only this data which of them appears to be riskier ?

I think high beta implies high risk. But it is not always the case.

If this is for a CFA Level 1 exam, the answer expected is probably C. In truth, as Adam points out, the beta tells you nothing about the risk, since it's just a measure of linear correlation with some market portfolio. Anything uncorrelated will have a low beta, regardless of its marginal distribution, so it's easy to construct scenarios where a low beta asset has catastrophic risk (something which systematically sells volatility, for instance).

I was asked this question in a quiz today. Professor said that since the beta of company is 1 , it is less risky because it follows the market trend. But I am not at all convinced.

A beta of 1 is considered market average. However, it is true that the lower the beta the less volatile. So C technically does have the highest volatility.