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Investment Volatility: A Critique of Standard Beta Estimation and a Simple Way Forward

European Journal of Operational Research, Vol. 187, pp. 1358-1367, 2008

U of Hertfordshire Business School Working Paper No. 2004:3

16 Pages Posted: 3 Jan 2008 Last revised: 2 Mar 2016

Chris Tofallis

University of Hertfordshire Business School

Date Written: 2006

Abstract

Beta is a widely used quantity in investment analysis. We review the common interpretations that are applied to beta in finance and show that the standard method of estimation - least squares regression - is inconsistent with these interpretations.

We present the case for an alternative beta estimator which is more appropriate, as well as being easier to understand and to calculate. Unlike regression, the line fit that we propose treats both variables in the same way. Remarkably, it provides a slope that is precisely the ratio of the volatility of the investment's rate of return to the volatility of the market index rate of return (or the equivalent excess rates of returns). Hence, this line fitting method gives an alternative beta, which corresponds exactly to the relative volatility of an investment - which is one of the usual interpretations attached to beta.

Added later: [The proposed measure is also called total beta.]

Keywords: investment analysis, beta, volatility, systematic risk, total beta

JEL Classification: G10, D81

Suggested Citation

Tofallis, Chris, Investment Volatility: A Critique of Standard Beta Estimation and a Simple Way Forward (2006). European Journal of Operational Research, Vol. 187, pp. 1358-1367, 2008; U of Hertfordshire Business School Working Paper No. 2004:3. Available at SSRN: https://ssrn.com/abstract=1076742

Chris Tofallis (Contact Author)

University of Hertfordshire Business School ( email )

College Lane
Hatfield, Hertfordshire AL10 9AB
United Kingdom

HOME PAGE: http://tinyurl.com/tofallis

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