A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

AVERAGE 
MONTHLY 
RETURN
VS. BETA: 1963–90 (FAMA AND
FRENCH STUDY)

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Because their comprehensive study covered a period of
almost thirty years, Fama and French concluded that the
relationship between beta and return is essentially flat. Beta,
the key analytical tool of the capital-asset pricing model, is
not a useful single measure to capture the relationship
between risk and return. And so, by the mid-1990s, not only

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practitioners but even many academics as well were ready to
assign beta to the scrap heap. The financial press, which
earlier had chronicled the ascendancy of beta, now ran feature
stories with titles such as “The Death of Beta,” “Bye, Bye
Beta,” and “Beta Beaten.” Typical of the times was a letter
quoted in 
Institutional Investor
from a writer known only as
“Deep Quant.”
*
The letter began, “There is a very big story
breaking in money management. The Capital-Asset Pricing
Model is dead.” The magazine went on to quote one
“turncoat quant” as follows: “Advanced mathematics will
become to investors what the Titanic was to sailing.” And so
the whole set of tools making up the new investment
technology—including even modern portfolio theory—came
under a cloud of suspicion.
AN APPRAISAL OF THE
EVIDENCE
My own guess is that the “turncoat quant” is wrong. The
unearthing of serious cracks in the CAPM will not lead to an
abandonment of mathematical tools in financial analysis and a
return to traditional security analysis. Moreover, I am not

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quite ready to write an obituary for beta at this time. There
are many reasons, I believe, to avoid a rush to judgment.
First, it is important to remember that stable returns are
preferable, that is, less risky than very volatile returns.
Clearly, if one could earn only the same return drilling for oil
as from a riskless government security, only those who loved
gambling for gambling’s sake alone would drill for oil. If
investors really did not worry at all about volatility, the
multitrillion-dollar derivative-securities markets would not be
thriving as they are. Thus, the beta measure of relative
volatility does capture at least some aspects of what we
normally think of as risk. And portfolio betas from the past
do a reasonably good job of predicting relative volatility in
the future.

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