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Beta and Expected Return

Hi all,

The relationship between return of an asset “i” and beta is Ri = Rf + betaX (Rm-Rf). Also, beta= correlation(i,m)x StDevi/StDevm.

To have an asset which return is above market return (Ri>Rm), the only way possible is with a beta>1. That means, since correlation(i,m) is by definition contained between -1 and 1, that for an asset to have greater returns than the market it must always have greater risk than the market.

Why it isn’t possible to have an asset with greater returns than the market and lower risks? Based on the curriculum, that ‘market’ is not the optimal one, and what we are trying to do here is to explore new assets to add to the current portfolio so it improves. But looks like in this definition of beta, the market is already the optimal one.

This quite messed up with my brain.

Thanks!

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vazquezcolorado wrote:
Hi all,

The relationship between return of an asset “i” and beta is Ri = Rf + betaX (Rm-Rf). Also, beta= correlation(i,m)x StDevi/StDevm.

To have an asset which return is above market return (Ri>Rm), the only way possible is with a beta>1. That means, since correlation(i,m) is by definition contained between -1 and 1, that for an asset to have greater returns than the market it must always have greater risk than the market.

Why it isn’t possible to have an asset with greater returns than the market and lower risks? Based on the curriculum, that ‘market’ is not the optimal one, and what we are trying to do here is to explore new assets to add to the current portfolio so it improves. But looks like in this definition of beta, the market is already the optimal one.

This quite messed up with my brain.

Thanks!

An asset with greater returns than the market and lower risk than the market would be underpriced, and everyone would want to buy it.  That will drive up the price today and reduce future expected returns.

Simplify the complicated side; don't complify the simplicated side.

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