Can a Bank Stock Have a Beta Over Two?
There is no cap or maximum to a stock’s beta. A stock’s beta represents the sensitivity of a firm’s stock returns to the overall market risk. Positive values of beta represent co-movement of the stock with the broad stock market, while negative beta values indicate that the stock price moves opposite the stock market. Stocks that are hypersensitive to stock market movements can have large beta values. Though bank stocks have been volatile, much of their price movements have not been in sync with the market and are not contributors to a high beta. Years after the financial crisis and stock market recovery, bank stocks have a range of beta values.
Beta and CAPM
Beta is a crucial variable in the Capital Asset Pricing Model (CAPM). CAPM creates an estimate for the expected value of a security based on its beta. This required or expected return is equal to the risk-free rate plus a market risk premium, and the market risk premium is the product of a security’s beta and the general market risk premium. The beta represents the sensitivity of a firm’s stock returns to the overall market risk. A stock with a beta greater than one is more volatile, thus riskier, than the overall equity market. A stock with a beta less than one is less volatile, thus less risky, than the overall equity market.
High Beta Investing
Though CAPM is a popular model, there have been empirical challenges to its prediction of higher beta stocks producing higher returns over time. Historically, high beta stocks have generally underperformed compared to the overall stock market. On average, low volatility stocks have done better historically. The use of beta in investing is also confounded by shifting relationships between a particular stock’s performance and that of the market, which often changes a stock’s co-movement with the market and its beta value over time.
Bank Stock Betas
Bank stocks have become more volatile and have higher beta values than they did in the past. In the late 80's banks were considered among the most financially stable institutions. This began to change in the 90's as bank stocks in developed nations became more volatile. The 2008 global financial crisis focused attention on the risk of bank stocks. In 2013, Bank of America stock and Citigroup stock both have beta values that are greater than two.
Bank Stock Investing
CAPM does not address the firm-specific and industry-specific risks that investors face when they buy bank stocks. In times of distress, bank stocks faced loan losses, government intervention and increased regulatory controls, and many went out of business. Concentrated bank investments are exposed to these risks even though they do not contribute to beta or to higher expected returns, according to CAPM.
Joe Escalada is a financial analyst. He earned a Master of Business Administration from the University of California at Davis and has passed all three Chartered Financial Analyst examinations. He has a bachelor's degree from the California Institute of Technology.