White-paper: Calculating CAPM Beta
[June 5, 2013] This is our third installment in an ongoing series of demonstrating select case studies. We'll use real financial data to construct models with the help of NumXL.
In this paper, we discuss the capital asset pricing model (CAPMi) underlying assumptions, define systematic and idiosyncratic risk, and outline their implication on the covariance among assets. Afterward, using a simple regression model, we compute the CAPM sensitivity factor (beta) for two different tech stocks: Microsoft and IBM. This paper will pave the way for more advanced factor modeling techniques in upcoming tutorials.
Why should you care? CAPM is a widely used and often quoted model in finance and trading. Developing a solid understanding of the theory, the implication on covariance matrix, and the practical issues encountered during its parameters' values calculation will prove to be a corner stone in risk management and portfolio performance attribution applications.