Abstract
This paper derives the relationship between a stock's beta and its weighting in the portfolio against which its beta is calculated. Contrary to intuition the effect of this market weight is in general very substantial. We then suggest an alternative to the conventional measure of abnormal return, which requires an estimate of a firm's beta when its market weight is zero. We argue that the alternative measure is superior, and show that it can differ substantially from the conventional measure when a firm has non-trivial market weight. The difference in abnormal returns may be disaggregated into a “market return effect” and a “beta effect”.
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