The financial discipline has developed a number of measures and analysis procedures to help investor measure and control financial risk in the development of investment port- folios. Risk can be identified as diversifiable risk and nondiversifiable risk Disible risk is that risk associated with specific firms and industries and includes labor conflicts. new competition, consumer market changes, and many other factors. This risk can be con trolled by larger portfolio sizes and by including stocks whose returns have negative cor relations. We developed these procedures in Chapter 5. Nendiversefable risk is that risk antociated with the entire economy. Shifts in the economy resulting from business cycles interational crisis, the evolving world energy demands, or others atfect all firms but do not have the same effect on each firm. The overall effect is measured by the average return en tocs such as measured by the Standard & Poor's 500 stock composite index ( SP500) The effect on individual firms is measured by the beta coefficient The beta coefficient for a specific firm is the slope coefficient that is obtained when the return for a particular firm is regressed on the returns for a broad index such as the S&P 500 This slope coefficient indicates how responsive the returns for a particular firm are to the overall market retums. In most cases the beta is positive, but in some limited cases a firm's returns will move in the opposite direction compared to the overall economy. If the firm's retums follow the market exactly, then the beta coefficient will be 1.1f the firm's returns are more responsive to the market, then the beta would be greater than 1, and if the firm's returns are less responsive to the market, then the beta will be less than 1. Uning financial analysis based on the capital asset pricing model, the required return on an investment is given by the following required turn marit en in From the previous result we see that a higher value at beta results in the need for a higher required return on investment. This higher required return would adjust for the fact that the stock return is influenced more heavily by the nondiversifiable market risk Diversiti cation through larger portfolios cannot adjunt for overall shifts in the market A financial manager might be concerned only about the actual value of the beta. How ever, a statistical analyst would also be concerned about the quality of the regression model that provides the estimate of beta and, thus, standard error of the coefficient, St dent'nt, R-squared, and other measures become appropriate. A statistical analyst would also be concerned about the time period represented by the data. We would like the pe riend to be as long as possible to obtain an estimate with a low variance. However, we also know that major changes occur over time that may result in a sea change in the economy In those cases we might be mixing data from two different kinds of economy, and the tenulting estimated beta might not be appropriate for present decisions. Thus, it is impor tant that the statistical analyst work closely with experienced financial analysts and fund managers who can help reflect on overall economic conditions Example 115 shows how we can estimate beta using our present knowledge of te gression analysis u11 Example 11.5 Estimation of Beta Coefficients The research department of Blue Star Investments has been asked to determine the beta coefficients for the firms Pearson PLC and Infosys, and you have been assigned the project. Both firms are large multinational organizations. Pearson is a wide range pub lisher and provider of various media, whereas Infosys is a large computer software and information services firm with headquarters in India