Why might it be useful to estimate the beta for a stock from returns on stocks within its industry rather than from the stock itself?
What will be an ideal response?
Estimating a beta using a regression is often imprecise because a firm's returns exhibit considerable idiosyncratic volatility. That is, much of the variation in a firm's return is driven by firm-specific events. This idiosyncratic volatility reduces the fit of the regression and increases the standard errors of the estimates. If firms in the same industry have about the same systematic risk, which is a reasonable assumption, their betas will be about the same as well. A portfolio of firms diversifies away a lot of idiosyncratic risk and is consequently much less variable than an individual firm's stock returns. Therefore, beta estimates from industry portfolios are more precise, and provide reasonable estimates for a firm's beta.
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