Journal of Risk & Control

The Industry Beta as a Substitute for the Individual Stock Beta – An Empirical Analysis

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• Abstract

   

  The beta factor is often used to determine the systematic risk when calculating the cost of equity as part of the company valuation. This study examines whether it makes sense to use the industry beta instead of the beta factor of a listed company. Accordingly, an empirical test is performed to determine whether the assumption that the individual stock betas within a sector are homogeneous is justified. The study refers to the stocks included in the German DAX index, whereby 32 out of the 40 stocks could be taken into account, which were divided into six different sectors. The beta factors are calculated on the basis of the monthly stock and index returns over the past five years.                    

  A multiple confidence interval comparison of all stocks included in a sector shows that there is no homogeneity of beta factors in four out of six sectors analyzed in this study, as significant differences in systematic risk could be detected in these sectors even with the very conservative Bonferroni method. The subsequent comparison of the individual beta confidence intervals with the respective industry beta shows that periods can be found for all sectors in which individual betas differ significantly from the industry beta. Consequently, the findings of this specific study suggest that when determining the cost of equity as part of an objective company valuation, the individual beta should not be replaced by an industry beta.

   

  JEL classification numbers: C12, G11.

  Keywords: Industry beta, confidence interval, Bonferroni method.