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For example, if the stock market went up by 20% in a given year, and a manager had a portfolio with a market-beta of 2.0, this portfolio should have returned 40% in the absence of specific stock picking skills. This is measured by the alpha in the market-model, holding beta constant. Occasionally, other betas than market-betas are used.
The alpha, beta and residual risk of the constructed active portfolio are found using the previously computed weights w i: = = = The overall risky portfolio for the investor consists of a fraction w A invested in the active portfolio and the remainder invested in the market portfolio. This active fraction is found as follows:
How to calculate beta Beta is calculated by taking the covariance between the return of an asset and the return of the market and dividing it by the variance of the market.
[] / [] is the "beta", return mentioned — the covariance between the asset's return and the market's return divided by the variance of the market return — i.e. the sensitivity of the asset price to movement in the market portfolio's value (see also Beta (finance) § Adding an asset to the market portfolio).
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Using beta to evaluate a stock’s risk. Beta allows for a good comparison between an individual stock and a market-tracking index fund, but it doesn’t offer a complete portrait of a stock’s ...
An estimation of the CAPM and the security market line (purple) for the Dow Jones Industrial Average over 3 years for monthly data.. In finance, the capital asset pricing model (CAPM) is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio.
With this equation, only the betas of the individual securities and the market variance need to be estimated to calculate covariance. Hence, the index model greatly reduces the number of calculations that would otherwise have to be made to model a large portfolio of thousands of securities.