2581-Advanced Financial Management-2425_S2

Assignment

When asked to estimate betas based on monthly data from past years, students ask if for the sake of consistency, they should use monthly average returns of both the market portfolio and risk-free assets.

The beta measures how much returns of a stock move when the return of the market moves. More specifically, it measures how much the return of a stock increases when the market return increases by 1 percentage point. It is a sensitivity metric and therefore does not necessarily depend on whether returns are monthly or annual. Therefore, we don't annualise the beta as it already captures the correct measure. By using monthly returns, the CAPM result will be a monthly return and so has to be annualised in the end.