Question

Provide possible reasons for the flat association between historical market betas and future stock returns. Are you aware of any evidence that supports your argument?

Answer 1

Most the stocks are thought to be less affected by cycles and usually have lower beta when we consider them for a longer time. Thus historic beta is neutralised in terms of market fluctuations, cyclic changes and gives long term overall value with respect to the market. Therefore, using the historic market beta for the future stock will give a flat trend.

For example, in 2008 Sub prime crisis worst affected sector was financial services. But when the market retired to normal these institutions were performing again better. So over a long time the beta association will be flat but for small time it will be very high or low.