Limitations of using Beta as a standard measure to assess risks
- To define limitation of using Beta, it's necessary to remember how Beta is used
- First of all, there are some problems using only Beta result to determine risk of an investment
- There is no rule about the period used to estimate Beta
- The choice of a return interval which measures historical returns
Risk reduction is needed to obtain security on expected returns. On the one hand some risks can be diversified, like unsystematic risk, and on the other hand systematic risk can not be diversified because they are inherent in the company's activity. There is only one exception, systematic risk can be diversified by investing in other markets. To reduce systematic risks which are market risks, there are tools like Beta available. Beta is a coefficient used to calculate the Security Market Line and the Capital Asset Pricing Model. Market risk refers to a risk which depends on movement of interest rate, foreign exchange rates, and prices of instrument in money. It is a risk when these systematic factors have a negative effect on the earnings and the financial institution's capital. Beta measurement assesses the sensitivity of individual security returns to systematic factors on the overall market portfolio. Thus this tool indicates how sensitive a portfolio is, to market movements.