Weekly Puzzle #5: The Magic of Beta
The Set up
In most finance text books, you are told that all you need to do to estimate the beta for a stock is to run a regression of returns on the stock against returns on the market index. The slope of the line is, of course, the beta. This avoids many key questions including:
- Over what period should the regression be run, and with what return intervals?
- What market index should you use for the regression?
- What exactly is the regresssion telling you about the beta for the stock?
- What is the beta telling you about the risk in your stock?
In this weekly puzzle, I have taken one company, GameStop, and estimated its beta against three different indices, using one of the most volatile time periods in its history, and you will have to make your judgment, based on these betas.
Against the S&P 500
- For GameStop, list out the key regression statistics (alpha, beta and R squared) in the regression. Do you notice any patterns? Can you explain them?
- If you are analyzing GameStop and were required to use this regression betas, would you? If not, why not? What would you use instead?
- During the period of the regression, GameStop had incredible volatility but its beta does not seem to reflect it. Explain why.