Investments, tenth edition

  Predicting Betas 

 Adjusted betas are a simple way to recognize that betas estimated from past data may not 

be the best estimates of future betas: Betas seem to drift toward 1 over time. This suggests 

that we might want a forecasting model for beta. 

 One simple approach would be to collect data on beta in different periods and then esti-

mate a regression equation:

 

   Current  beta

5 a 1 b (Past beta) 

 (8.30)  

Given estimates of  a  and  b,  we would then forecast future betas using the rule

 

   Forecast  beta

5 a 1 b (Current beta) 

 (8.31)  

There is no reason, however, to limit ourselves to such simple forecasting rules. Why not 

also investigate the predictive power of other financial variables in forecasting beta? For 

example, if we believe that firm size and debt ratios are two determinants of beta, we might 

specify an expanded version of Equation 8.30 and estimate

   Current  beta

5 a 1 b

1

(Past beta)

1 b

2

(Firm size)

1 b

3

(Debt ratio) 

Now we would use estimates of  a  and  b  

1

  through  b  

3

  to forecast future betas. 

 Such an approach was followed by Rosenberg and Guy,  

17

   who found the following 

variables to help predict betas:

 

    1.  Variance  of  earnings.  

   2.  Variance  of  cash  flow.  

   3.  Growth in earnings per share.  

   4.  Market  capitalization  (firm  size).  

   5.  Dividend  yield.  

   6.  Debt-to-asset  ratio.    

 Rosenberg and Guy also found that even after controlling for a firm’s financial charac-

teristics, industry group helps to predict beta. For example, they found that the beta values 

of gold mining companies are on average .827 lower than would be predicted based on 

financial characteristics alone. This should not be surprising; the  2 .827 “adjustment factor” 

for the gold industry reflects the fact that gold values are inversely related to market returns. 

  Table  8.4  presents beta estimates and adjustment factors for a subset of firms in the 

Rosenberg and Guy study.  

 

  

  

17

 Barr Rosenberg and J. Guy, “Prediction of Beta from Investment Fundamentals, Parts 1 and 2,”  Financial 

 Analysts  Journal,  May–June and July–August 1976. 

 Compare the first five and last four industries in  Table 8.4 . What characteristic seems to determine whether 

the adjustment factor is positive or negative? 

 CONCEPT CHECK 

8.5 

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