Stock-Price Beta Estimation for Google, Inc. (Case Study)
A.
Describe
some of the attributes of an ideal risk indicator for stock market investors.
B. On the
Internet, go to Yahoo! Finance (or msnMoney) and download weekly price
information over the past year (52 observations) for GOOG and the Nasdaq
market. Then, enter this information in
a spreadsheet like Table 16.6 and use these data to estimate GOOG=s
beta. Describe any similarities or
dissimilarities between your estimation results and the results depicted in
Figure 16.8.
C.
Estimates
of stock-price beta are known to vary according to the time frame analyzed;
length of the daily, weekly, monthly, or annual return period; choice of market
index; bull or bear market environment; and other nonmarket risk factors. Explain how such influence can undermine the
usefulness of beta as a risk indicator.
Suggest practical solutions.
CASE STUDY SOLUTION
A.
An ideal measure of stock market risk would be
simple to derive, accurate and consistent from one year to another. With an ideal risk measure, investors are
able to control the risk exposure faced during volatile markets with
well-targeted and well-timed investment buy/sell decisions. For example, suppose an elderly investor
wants to maintain an exposure to the equity markets during retirement, but
wants to limit risk to regulate the possibility of devastating losses. With an ideal risk measure, retired investors
could precisely tilt portfolio allocation toward securities with low risk
characteristics. Alternatively, if an
investor anticipated a surge in stock prices following a decline in interest
rates, precise risk measures could help such an investor tilt an investment
portfolio toward more volatile stocks.
The
usefulness of stock market risk indicators diminishes to the extent that they
fail to provide accurate and consistent measures of risk exposure from one year
to another. In fact, an important limitation
of risk estimators derived from the CAPM is that they vary from one period to
another in ways that prove highly unpredictable. When betas vary from one year to another in
ways that are essentially random and unpredictable, betas fail to provide investors
with a risk assessment tool that can be used to effectively manage portfolio
risk.
B.
It will be a real eye-opener to students when they
estimate stock-price beta for GOOG over a more recent time period using weekly
returns and compare those results with the beta estimate derived from the
monthly returns reported in Table 16.6 for the 52-week time period shown in
Figure 16.8. Stock-price beta estimates
often vary markedly depending upon the time frame analyzed, and according to
the daily, weekly, monthly, or annual return interval examined. Such differences, if severe, can undermine
the credibility of stock-price betas as useful risk indicators.
C.
Empirical estimates of stock-price beta are known
to vary according to the time frame analyzed; length of the daily, weekly,
monthly, or annual return period; choice of market index; bull or bear market
environment; and other nonmarket risk factors.
For example, estimates of beta tend to be imperfect risk measures because
return volatility for the overall market is very difficult to measure. On the nightly news, when commentators talk
about the market being up or down, they often refer to moves in the DJIA. Whereas the DJIA offers good insight
concerning changes in the prices of large blue chip companies, it offers little
insight concerning volatility in the returns earned by investors in smaller
high-tech stocks. From the perspective
of many individual and institutional investors, the S&P 500 Index gives
superior insight concerning moves in the overall market, but like the DJIA, the
S&P 500 is dominated by large blue chip companies. Although the Nasdaq and Russell 2000 indexes
are popular measures of high-tech and smaller stocks, they are much less
informative about changes in the overall market. While there is a high degree of correlation
in rates of return earned on the DJIA, S&P 500, Nasdaq, and Russell 2000
indexes, slight differences can have big effects on beta estimates.
From
a theoretical perspective, the most appropriate benchmark would be a market
index that included all capital
assets, including stocks, bonds, real estate, collectibles, and so on. Unfortunately, no such market index is
available. To greater or lesser degree,
this affects the accuracy of all beta estimates and undermines confidence in
beta as an accurate measure of security risk.
Another important problem faced in obtaining consistent and reliable
beta estimates is the fact that beta estimates are sensitive to the length of
time over which stock return data are measured.
When beta estimates differ according to daily, weekly, monthly or annual
returns, the usefulness of stock-price beta as a consistent measure of risk is
greatly diminished.
The
presence of market index bias and return interval bias, among other
problems, makes it imperative that beta
comparisons among individual companies reflect identical estimation periods,
return intervals, and appropriate market benchmarks.