David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 12 Risk and information
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Riskness of each asset (beta)
Each share's risk is measured by
its beta, which shows how that
share's returns move with returns
in the market as a whole. The
higher the beta, the more the
inclusion of the share in a portfolio
will increase the total portfolio risk.
The data show that riskier shares
with higher betas must offer a
higher return on average to
compensate for this disadvantage.
Figure 12.2
Risk-return relationship for company shares
Table 12.6
Beta for selected sectors
Retailing 0.96
Cosmetics 0.66
Banks 1.27
Chemicals 0.81
-
Energy 0.82
Brewing 0.66
-
Tobacco 0.59
Source: Risk Management Services, 2003.
Media
Defence
Paper
Mining
Textiles
Personal products
Clothing
1.2
1.14
0.99
1 .19
0.27
0.63
0.71
on average offer high rates of return that compensate for their undesirable risk characteristics. Figure 12.2
shows the results of a pioneering study by Professors Black, Jensen and Scholes5 using stock market data
from 1931 to 1965. Average returns on individual shares rise steadily with the shares' beta as the theory
predicts. Table 12.6 shows recent estimates of beta for selected sectors of the FTSE index.
To sum up, individual share prices depend both on expected or average returns and on risk characteristics.
The risk characteristics of a firm's shares determine the expected return its shares must offer to compete
with other shares. For a given required return, higher anticipated income (dividends or capital gains)
means a higher current share price.
The riskiness of a firm's shares refers not to variability of the share's return in isolation from the rest of the
market. This is why beta matters. Adding a risky asset to the portfolio reduces the risk of the portfolio
provided the share's beta is less than 1. Low beta shares can be individually risky; nevertheless, taken with
other shares they reduce portfolio risk and are therefore desirable. Low beta shares have an above-average
price and a below-average rate of return to offset this advantage; high beta shares must offer an aboveaverage
expected return to be competitive.
5 Black, F., Jensen, M. C. and Scholes, M. (1972) The capital asset pricing model: some empirical tests, in M. C. Jensen (ed.),
Studies in the Theory of Capital Markets, Praeger, pp. 79-121.
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