Beta and the market
Regress a real stock against the S&P 500 to split its returns into market, alpha and noise.
What a short-term Treasury pays. Returns are measured above it.
Extra yearly return investors expect for holding the whole market.
60 months from Oct 2021. Each dot is one month. The slope of the line is beta.
Over these 60 months, when the S&P 500 moved 1%, Nvidia moved about 2.21% on average. The market explains 48% of its ups and downs; the rest is news specific to the company. CAPM says an asset with this beta should earn about 16.2% a year.
Where the risk comes from
Specific risk can be diversified away by holding many assets, so CAPM says it earns no reward. Only market risk, measured by beta, is paid for.
Beta is not a constant
Beta measured over each trailing three years of Nvidia.
The dashed line is a beta of 1, moving exactly with the market.
Try this
- Compare Coca-Cola with Nvidia. Which one is the defensive stock, and how can you tell from the dots?
- Pick long-term Treasuries or gold. What does a beta near zero, or below it, mean for a portfolio?
- Watch Tesla's rolling beta. Would a single beta number have described it well?
The math
- return of the asset
- return of the market (S&P 500)
- risk-free rate
- sensitivity to the market
- return the market doesn't explain
- specific, diversifiable noise
Monthly adjusted prices, dividends reinvested. Historical results describe the past and are not a forecast or a recommendation.