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Does Beta Define Real Stocks' Risk?

Nissim Ben David and Evyatar Ben David

After finding a poor relation between average return and beta’s of the 25 largest firms traded in the NASDAQ, we modified the classical CAPM model in order to improve the predictive power of the model. Our first approach is that the capital market line should pass through the market portfolio while risk free interest rate would be estimated by a linear regression that minimizes the square distance of various stock data from the line. The second approach is that the traditional market line is valid, but the formula for calculating beta should be modified. Under the first approach, we find a very large interval for expected return while under the second we find unreasonable values for beta. According to our findings, we conclude that factors other than beta should be used for determining risk.