One measure of the risk or volatility of an individual stock is the standard deviation of thetotal return (capital appreciation plus dividends) over several periods of time. Althoughthe standard deviation is easy to compute, it does not take into account the extent to which theprice of a given stock varies as a function of a standard market index, such as the S&P 500. As a result, many financial analysts prefer to use another measure of risk referred to as beta. Betas for individual stocks are determined by simple linear regression. The dependentvariable is the total return for the stock and the independent variable is the total return forthe stock market.* For this case problem we will use the S&P 500 index as the measure ofthe total return for the stock market, and an estimated regression equation will be developedusing monthly data. The beta for the stock is the slope of the estimated regressionequation (b1). The data contained in the file named Beta provides the total return (capitalappreciation plus dividends) over 36 months for eight widely traded common stocks andthe S&P 500.The value of beta for the stock market will always be 1; thus, stocks that tend to rise andfall with the stock market will also have a beta close to 1. Betas greater than 1 indicate thatthe stock is more volatile than the market, and betas less than 1 indicate that the stock isless volatile than the market. For instance, if a stock has a beta of 1.4, it is 40% more volatilethan the market, and if a stock has a beta of .4, it is 60% less volatile than the market.You have been assigned to analyze the risk characteristics of these stocks. Prepare a reportthat includes but is not limited to the following items.
a. Compute descriptive statistics for each stock and the S&P 500. Comment on your results. Which stocks are the most volatile?
b. Compute the value of beta for each stock. Which of these stocks would you expect toperform best in an up market? Which would you expect to hold their value best in adown market?
c. Comment on how much of the return for the individual stocks is explained by the market.