How to Calculate Beta Using Expected Return & Volatility

by C. Taylor

A stock's beta value measures the stock's price volatility with respect to the overall market. Values greater than 1.0 describe a stock with more price movement than the market, but values less than 1.0 indicate more gradual movements. The expected return describes the rate of return that is required to justify the riskiness of the stock. The expected return is calculated using a stock's beta value along with an alternative, risk-free investment and the market's average return. However, if you already have the expected return, you may reverse the calculation to extract the beta value.

Look up the market's average return and that of a risk-free alternative investment. A risk-free investment is one that virtually guarantees a certain return, such as government bonds or savings accounts. The overall market return is approximately 8.0 percent, but if your expected return uses a different index, you may find it through online resources, such as money.MSN.com, finance.yahoo.com or google.com/finance.

Subtract the risk-free rate from the expected return. As an example, suppose you could expect 10.0 percent return on a stock, but the alternative risk-free rate was 4.0 percent. In that case, you would subtract 4.0 percent from 10.0 percent to get 6.0 percent.

Subtract the risk-free rate from the average market return. In the example, subtracting 4.0 percent from 8.0 percent gives you a difference of 4 percentage points.

Divide the first subtraction by the second subtraction to calculate beta. In the example, dividing 6.0 percent by 4.0 percent gives you a beta value of 1.5. This means your stock is 1.5 times more volatile than the market.

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