What is the Beta Coefficient?

The beta coefficient measures the volatility of the return on a financial instrument in relation to the market as a whole. A security that responds strongly to changes in the market is assigned a high beta, while a security that has a minimal response to changes in the market is assigned a low beta. For example, a security with a beta of 1.1 is 10% more volatile than the general market. Securities with high beta values are considered to have a strong potential return, but also a higher risk of loss. Securities with a low beta are considered to be safer, but also have a low probability of experiencing high returns. If a security has a beta of 1, its price should move with the market.

Importance of the Beta Coefficient

investors use the beta coefficient to decide whether to include a security in their portfolio of investments, because it helps them to determine how it will respond to fluctuations in the market.

Disadvantages of the Beta Coefficient

The main concern with relying on the beta coefficient is that it is calculated entirely from historical data, and so is not necessarily an accurate method for judging how a security will respond to future market fluctuations. This is especially true when the issuer of a security is altering its business model, which may cause its beta to change to a substantial degree.