Beta Analysis in CAPM

This page addresses the Beta in the CAPM. The component of the risk premium added to the risk-free rate in the CAPM is the company or industry specific risk that is measured with beta. The beta is a statistic that is centred around 1.0 for companies that have the same risk as the overall market. In general companies with fixed or regulated prices and stable demand such as IPP’s and regulated distribution companies should have betas substantially below 1.0. Beta seems like a straightforward number to calculate with the SLOPE function in excel. But betas can vary from using different samples; different time periods; different market time increments (daily, weekly or monthly data); and different market indices. Betas that measure the risk of the utility industry can also be adjusted for the debt gearing of companies. For Pakistan this is complicated by the fact that the nine of the IPP companies regulated by NEPRA have market data and betas can be computed.

You may think that once the stock price data is available, the beta which is the slope of the change in the stock versus the change in the index is a straightforward number to compute. But as with other subjects, there are uncertainties with the calculation and the implied company risk can vary a lot. This is demonstrated when computing betas for the nine IPP’s in Pakistan which highlight frustrating issues with the beta statistic. Table 5 demonstrates differences in betas that arise from different historic time periods, different time increments (monthly or daily) and different market indices (KSE or S&P500). In Section 3 I explain that the most appropriate beta is the beta computed using the S&P 500 index with monthly data with a median of .518.  I have confirmed the beta with international utilities that reflect the general risk of regulated companies that do not have risks associated with demand and supply, fashion changes, obsolescence, and other items. This confirms the low risk of regulated companies.  I have applied a beta of .6 in my recommendation.