Lesson 4 of 6 · All lessons in this module
  1. Return-generating models, the market model and betaVideo lesson
  2. The CAPM: assumptions, the SML and its limitsVideo lesson
  3. Estimating beta for the cost of equity
  4. Industry betas: unlevering and relevering
  5. The market risk premium and the country risk premium
  6. APT and the four-factor model for the cost of equity

This lesson is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.

Lesson 4 of 6 · 13 min

Industry betas: unlevering and relevering

When a company's own beta is noisy or unavailable, estimate the business risk of comparable companies by unlevering their average beta, then relever it at the company's own debt-to-equity ratio.

In short

  • A single stock's beta is noisy because much of its return variation is diversifiable. A portfolio of comparables gives a beta with a lower standard error and a higher correlation with the market.
  • Unlevered beta βu\beta_u = business (asset) risk without financial leverage: βu=βL,Comps/[1+(1−t)(D/MVE)]\beta_u = \beta_{L,Comps}/[1 + (1 - t)(D/MVE)], using comparables' averages.
  • Relever at the firm's own leverage: βL,firm=βu[1+(1−t)(D/MVE)firm]\beta_{L,firm} = \beta_u[1 + (1 - t)(D/MVE)_{firm}].
  • A levered beta is never below its unlevered beta: βL,Comps≥βu≤βL,firm\beta_{L,Comps} \geq \beta_u \leq \beta_{L,firm}. The adjustment matters most when leverage differs a lot.
  • Uses: noisy regression betas, private companies and recent IPOs, and firms that recently changed leverage. Caveat: the comparables must share the firm's asset risk.

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