Question

Can I use CAPM model to find cost of equity if my Beta is negative?
Consider Rf=5%, Rm=15% and Beta=-1, in this case My E(R)=-5%, what does this signifies...?

Answer 1

How did you calculate your beta?

Answer 2

Negative beta would signify negative correlation between market's and asset's returns. I am not sure if it is possible.

Answer 3

It is possible Fiver...just look at gold for instance...

Answer 4

Yes, you are right. But still, he wants to find cost of equity. He probably does not value gold.

Answer 5

A Negative Beta is possible.It means that the acquisition of the asset will be similar to insurance.This would imply that you are actually reducing your portfolio's risk by buying one asset with a negative Beta.

Answer 6

The above data is fictitious..I just wanna know if it is possible or not. AND if it is, then what does the expected return signifies?

Answer 7

Just a small reminder: beta is a measure a market risk, not total risk. The return calculated with the Beta is remuneration of the MARKET risk of the asset, not total risk. The other risk than the market risk is not supposed to be remunerated since it can/shoud be eliminated through diversification.

Now for your questions:
1) It is possible YES.
2) the expected return signifies that: in a diversified portfolio, the addition of your asset would decrease your portfolio risk. Therefore, your asset does not "deserve" a return, since it has no market risk. On the contrary, you could pay for it since it is providing you with a kind of hedging.

Answer 8

Really simple explanation. Think about a normal, plain vanilla company like Heinz. It's equity will have a positive beta. Let's assume its equity beta is 0.60.

If you short the equity of Heinz, it would have a beta of -0.60. This means that it will have (under non-pathological assumptions) a negative expected return,

So, as Pierre stated, a negative beta is not only possible, it is extremely easy to find a negative beta trade. And, since a negative beta trade would reduce your portfolio volatility, you would pay for this insurance/hedge by accepting a negative expected return.