Prediction of Beta from Investment Fundamentals

To understand why true beta changes, consider two imaginary future events with uncertain outcomes and two common stocks, A and B. One event has strong energy implications; the other, strong inflation implications. Assuming that, relative to the market, stock A responds two-thirds as much to energy and two times as much to inflation, whereas stock B responds four-thirds as much to energy and nil to inflation, stock B will show the higher volatility if the energy situation changes and stock A, the higher volatility if the inflation situation changes. Depending on whether energy or inflation is currently the greater source of uncertainty, stock A or stock B will have the higher beta.