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

© Milt Priggee / Pensions &
Investments.
www.miltpriggee.com. Reprinted
by permission.
Second, as Professor Richard Roll of UCLA has argued,

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we must keep in mind that it is very difficult (indeed
probably impossible) to measure beta with any degree of
precision. The S&P 500 Index is not “the market.” The total
stock market contains many thousands of additional stocks in
the United States and thousands more in foreign countries.
Moreover, the total market includes bonds, real estate,
commodities, and assets of all sorts, including one of the most
important assets any of us has—the human capital built up
by education, work, and life experiences. Depending on
exactly how you measure the “market,” you can obtain very
different beta values. One’s conclusions about the capital-
asset pricing model and beta as a measure of risk depend very
much on how you measure beta. Two economists from the
University of Minnesota, Ravi Jagannathan and Zhenyu
Wang, find that when the market index (against which we
measure beta) is redefined to include human capital and when
betas are allowed to vary with cyclical fluctuations in the
economy, the support for the CAPM and beta as a predictor
of returns is quite strong.
Third, there is some evidence that returns are positively
related to beta when measured over a much longer period,
such as 1927 to the present.

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Finally, investors should be aware that even if the long-run
relationship between beta and return is flat, beta can still be a
useful investment management tool. Were it in fact the case
that low-beta stocks will dependably earn rates of return at
least as large as high-beta stocks (a very big “if” indeed), then
beta would be even more valuable as an investment tool than
if the capital-asset pricing model held. Investors should scoop
up low-beta stocks and earn returns as attractive as for the
market as a whole but with much less risk. And investors
who do wish to seek higher returns by assuming greater risk
should buy and hold low-beta stocks on margin, thereby
increasing their risk and returns. Moreover, beta may be a
useful risk measure during sharp market swings. High-beta
stocks did tend to fall more than low-beta stocks in all of the
bear market periods during the past fifty years. High-beta
tech stocks took a particularly painful beating during the bear
market of the early 2000s. What is clear, however, is that
beta, as usually measured, is not a substitute for brains and
cannot be relied on as a simple predictor of long-run future
returns. Nevertheless, reports of beta’s total demise are, in
my judgment, premature.

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