R-Squared vs. Beta: An Overview

Beta is an estimate of the marginal effect of a unit change on the return of a security. R-squared is an estimate of how well beta and alpha help to explain the return on a security. Most stock investors are familiar with the use of beta and alpha coefficients to understand how securities have performed against a market index. R-squared is also a useful tool for the investor, however.

These statistics can indicate how cl🍬osely the movement of one investment parallels the movement of an index over time. Beta can be used to estimate the size of the direct relationship between the market and the security. R-squared is used to determine the reliability of the relationship between the index and alpha and beta.

Beta

Beta is a numerical representation of how much the return of an overall market index impacts the return on 💎a chosen security. A beta of 1 indicates that an increase or decrease in the market index return is associated with an equal increase or decrease in the return on the selected security.

Beta greater than 1 means that the chosen security is more sensitive to the return on its general market index. Beta less than 1 is relatively insensitive to overall market returns. Negative beta values mean that the selected security tends to have an inverse relationship to its overall market rate of return.

Finding two perfectly related sec🍃urities such as beta equal to 1 is highly unusual. Readings below 1 indicate that the security is less volatile than the benchmark. Readings of exactly 1 indicate that its price should move with the benchmark. Readings greater than 1 indicate that the asset is more volatile than the benchmark.

Alpha Coefficient

The alpha coefficient is often v💦iewed as a key performance indicator for stock funds. Alpha is a measure💮 of the risk-adjusted performance of a fund or asset compared to a benchmark index.

An alpha of 1.0 indicates that the investment outperformed the index by 1%. An alpha of less than 0 indicates that the investment returned less than the benchmark when adjusted for their respective volatility.

R-Squared

澳洲幸运5官方开奖结果体彩网:R-squared (R²) is a method an investor or analyst can use to determine how well alpha and beta capture the relationship between the return on a security and the return on the overall market. R² is also referred to as the coefficient of determination or the proportion of the variation in the security's return that's determined by the market return given the estimated values of alpha and beta.

R² definℱes the practical value of alpha and beta on 🎉a scale from 0 to 1.

A high R-squared number from .85 to 1 indicates that alpha and beta together explain much of the variation in the returns on a security. A low R² below about .7 indicates that there's little relationship between the performance pattern of the security as estimated by alpha and beta and that of the index. The returns on the security may be more random or they may be explained by unobserved factors other than the market index return.

You can determine R² by using a standard formula. Some mutual fund companies report the R² of their funds in their advertising literature but others do not. Yahoo! Finance and 澳洲幸运5官方开奖结果体彩网:Morningstar calculate and publish R² data as well as beta figures daily.

The Bottom Line

Investments with a high beta reading♕ are generally seen as r🔜elatively risky. Stocks with a high beta tend to rise more quickly than their benchmarks in bull markets and fall more quickly in bear markets.

An investor should also consider R², however, because it indicates the reliability of alpha and beta. High or low beta with a low R² may not be all that meaningful or it may even be deceptive to the unwary. A high R² suggests that the given estimates𒊎 of alpha and beta should be taken more seriously.

Disclosure: Investopedia does not provide investment advice. Investors should consider their risk tolerance and investment objectives before making investment decisions.