β = 1 Does a Better Job than Calculated Betas

Abstract

We compute the correlations of the annual stock returns (1989-2008) of the Dow Jones companies with a) β Rm; and with b) Rm; and find that the second correlation (assuming beta = 1 for all companies) is higher than the first one, on average, and for all companies except Caterpillar and General Motors. Rm is the return of the S&P 500. Beta = 1 works better than calculated betas!

Not surprisingly, Adjusted betas (0.67 calculated beta 0.33) have higher correlation than calculated betas. But Adjusted betas have lower correlation than beta = 1.

We do the exercise with 4 calculated betas every year end vs. the S$P 500, using: a) monthly data of last 5 years; b) monthly data of last 2 years; c) weekly data of last 5 years; d) daily data of last 5 years. We find similar results with the four betas.

Despite this results, Fernandez (2009) reports that 97.3% of the professors that justify the betas use regressions, webs, databases, textbooks or papers (the paper specifies which ones), although many of them admit that calculated betas “are poorly measured and have many problems”. Only 0.9% of the professors justified the beta using exclusively personal judgement.

Keywords: beta, historical beta, calculated beta, adjusted beta, common sense

JEL Classification: G12, G31, M21