Lesson 11 of 20 · 6 min
Beta without statistics
Beta is a multiplier on market moves, and multipliers work in both directions.
Beta is usually introduced with a regression. It does not need one. Beta is simply the answer to: when the whole market moves one percent, how much does this position typically move?
A beta of 1.0 means it moves with the market. A beta of 0.6 means it typically moves about six tenths as much — a defensive utility might look like this. A beta of 1.8 means it typically moves nearly twice as much, which is common for high-growth or highly indebted companies. Beta is a description of past sensitivity, not a promise about the future, and it says nothing about moves caused by the company itself rather than the market.
Where beta becomes urgent is in combination with borrowing. Your headroom is measured against your collateral, and your collateral falls by your portfolio's beta times the market move, not by the market move. A person who mentally budgets for a 20 percent market decline while holding a portfolio with a beta of 1.6 has actually budgeted for a 12.5 percent market decline. The mismatch is invisible until it is not.
One more layer: high-beta holdings usually carry lower advance rates, for exactly the reason discussed in the haircut lesson. So the same characteristic that makes a position fall further also gives it less lending value to fall from. The two effects compound rather than offset.
Key terms
- Beta
- How much a position typically moves for each 1% move in the broad market. Above 1 amplifies; below 1 dampens.
- Portfolio beta
- The weighted average beta of your holdings. It is what your collateral value actually responds to.
- Idiosyncratic move
- A price change caused by the specific company rather than the market. Beta does not describe these at all.
Worked example
The market fell 20%. What did you fall?
Two $600,000 portfolios, each with a $300,000 balance and a 70% threshold. Portfolio beta 0.8 versus 1.6.
- Market decline
- 20%
- Low-beta portfolio value
- $504,000
- Low-beta LTV
- 59.5%
- High-beta portfolio value
- $408,000
- High-beta LTV
- 73.5%
20% × 0.8 = 16% decline
Under the 70% threshold.
20% × 1.6 = 32% decline
Breached.
Same market, same loan, same threshold. One account is fine and the other is in a call, and the only difference was the multiplier.
Check yourself
Your portfolio has a beta of 1.5 and you can absorb a 30% decline in collateral value before a call. What market decline reaches your threshold?
Saved in this browser only. No account, nothing sent anywhere.
Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.