Can beta be negative?

May 02, 2016
Apparently it can. Read on to figure out why.

Can beta be negative?

Aswath Damodaran, professor of finance at the Stern School of Business, New York University, believes so. Below is the answer from his blog.

The reason negative betas pose a conundrum to many finance students is that they seem to go against intuition. After all, if a beta of 1 is average risk and a beta of 0 is riskless, how can an investment have negative risk?

Here is the answer. Yes, beta can be negative. To see how and why, consider what beta measures: the risk added by an investment to a well diversified portfolio. By that definition, any investment that when added to a portfolio, makes the overall risk of the portfolio go down, has a negative beta.

A more intuitive way of thinking about this is that a negative beta investment represents insurance against some macro economic risk that affects the rest of your portfolio adversely.

A standard example that is offered for a negative beta investment is gold, which acts as a hedge against higher inflation (which devastates financial investments such as stocks and bonds). It is also true that puts on stocks and selling forward contracts against indices will have negative betas.

What are the consequences of a negative beta? The expected return on that investment will be less than the risk-free rate.

Are there actual investments out there that have negative betas? I know that there are stocks with negative regression betas, but those are the mostly the result of something strange happening during the period of the regression - an extended lawsuit or acquisition battle throwing off the correlation with the market- rather the true betas. In fact, in my 15 years of updating betas by sector, I have still not found a sector with a negative beta.

Furthermore, even assets that, in theory, could have negative betas (gold, for instance) seem to have positive betas when securitized (gold shares, gold ETF). There seems to be something about the securitization process that makes real assets behave more like financial assets.

A quick refresher on beta.....

Beta measures the volatility of a stock compared with the volatility of the market as a whole. A high beta means the stock price will move faster than a stock with low beta. High beta means high volatility, but also the possibility of high returns.

Let's say the beta value of the entire stock market, as measured by an index, is 1. A stock with a beta value of 1 will see its price move with that of the index. Investors with low tolerance for volatility would be happy with a stock that has a beta value of 1 or lower. An investment with zero beta means no volatility, like cash.

A negative beta correlation would mean an investment that moves in the opposite direction from the stock market. When the market rises, then a negative-beta investment generally falls. When the market falls, then the negative-beta investment will tend to rise.

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