In CAPM, what does beta measure?

In CAPM, what does beta measure?

• A. Systematic risk or market sensitivity of a security's returns
• B. Unsystematic risk
• C. Liquidity risk
• D. Inflation risk

Answer: (A)

Beta measures the sensitivity of a security's returns to movements in the overall market, capturing the amount of systematic risk it carries. In CAPM, the expected return of a security is driven by the market risk premium scaled by beta plus the risk-free rate, so beta tells you how much the security tends to follow or amplify market swings. A beta above 1 means the security moves more than the market on average, a beta below 1 means it moves less, and a beta of 0 implies little or no market correlation. This focuses on systematic risk—the part of risk that cannot be eliminated by diversification. Unsystematic risk, along with liquidity and inflation risks, are not measured by beta and are not the driver of CAPM-based expected returns.

Beta measures the sensitivity of a security's returns to movements in the overall market, capturing the amount of systematic risk it carries. In CAPM, the expected return of a security is driven by the market risk premium scaled by beta plus the risk-free rate, so beta tells you how much the security tends to follow or amplify market swings. A beta above 1 means the security moves more than the market on average, a beta below 1 means it moves less, and a beta of 0 implies little or no market correlation. This focuses on systematic risk—the part of risk that cannot be eliminated by diversification. Unsystematic risk, along with liquidity and inflation risks, are not measured by beta and are not the driver of CAPM-based expected returns.