Is beta a true measure of risk for Indian stocks?

Abstract

India has two major stock exchanges – the Bombay Stock Exchange (BSE) and The National Stock Exchange (NSE). While the BSE is Asia’s oldest stock exchange, and is also the fastest stock exchange in the world , it became electronic only in the year 1995 . NASDAQ, on the other hand was the world’s first electronic stock exchange and started operations in 1971 . Indian stock market thus lags by 25 years in terms of market development and efficiency. A comparison of the sizes of these exchanges is also a proof of how far India needs to go – the BSE’s market capitalisation of USD 0.08bn , is a small fraction of NASDAQ’s market capitalisation of USD 12.62bn . Apart from these, retail investor participation is also an important measure of development of a robust equity market. In India, in 2013, the participation of retail investors stood at a dismal 4.45% of the population, compared to 48.8% in the United States . This poor participation can be attributed to, among other things, information asymmetry and poor information quality . To invest smartly, ideally investors should weigh return to the risks. One of the important measures of risk in the Equities market is Beta. Therefore, having accurate Beta estimates is of significance. In our study, we attempt to study Beta, for the Indian Equity market and how the poor quality of available Beta might be badly affecting investor confidence. OBJECTIVE OF STUDY:- Small and Mid cap companies in India are traded infrequently and therefore there are fewer data points to calculate Beta. Our objectives, therefore are to check: 1. How accurately does Beta measure risk? This is apart from the variation that we can expect to see because of change in time horizons. 2. How much does the inaccuracy in Beta, if any, translate into expected returns? This shall be seen in the context of True Beta assumed and the Beta used in daily parlance.