 Historical Market Betas: The standard procedure for estimating the CAPM beta is to regress (ordinary least squares) stock returns Rj against market returns Rm: Rj = a + b Rm where a = Intercept from the regression The length of the estimation period - A longer estimation period provides more data, but the firm itself might have changed in its risk characteristics over the time period. (5 years) The choice of return interval - Using daily or intraday returns will increase the number of observations in the regression, but it exposes the estimation process to a significant bias in beta estimates related to nontrading (especially for small firms). (Daily interval for large cos and weekly for small) The choice of market index - The right index to use in analysis should be determined by the holdings of the marginal investor in the company being analysed. (Sensex, Nifty 50, BSE 100, BSE 500) Fundamental Betas: The beta of a firm is determined by three variables:
If all of the firm's market risk is borne by the stockholders (i.e., the beta of debt is zero), and debt creates a tax benefit to the firm, then,  where B(L) = Levered beta for equity in the firm The equity beta of a company is determined by both the riskiness of the business it operates in and the amount of financial leverage risk it has taken on. Financial Leverage - The degree to which a company is utilizing borrowed money, measured by the debt-to-equity (D/E) ratio Operating Leverage - The degree to which a company incurs a combination of fixed and variable costs Bottom-Up Betas - Estimation for IPOs, private businesses, and divisions of companies |
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