Current beta a b (Past beta) (10.14) Given estimates of a and b, we would then forecast future betas using the rule

Forecast beta a b (Current beta)

There is no reason, however, to limit ourselves to such simple forecasting rules. Why not also investigate the predictive power of other financial variables in forecasting beta? For example, if we believe that firm size and debt ratios are two determinants of beta, we might specify an expanded version of equation 10.14 and estimate

Current beta a b1 (Past beta) b2 (Firm size) b3 (Debt ratio) Now we would use estimates of a and b1 through b3 to forecast future betas.

III. Equilibrium In Capital

Markets

10. Single−Index and

Multifactor Models

The McGraw−Hill

Companies, 2001

308 PART III Equilibrium in Capital Markets

Table 10.3

Industry Betas and Adjustment Factors

Industry Beta Adjustment Factor

Agriculture 0.99 .140

Drugs and medicine 1.14 .099

Telephone 0.75 .288

Energy utilities 0.60 .237

Gold 0.36 .827

Construction 1.27 .062

Air transport 1.80 .348

Trucking 1.31 .098

Consumer durables 1.44 .132

Such an approach was followed by Rosenberg and Guy12 who found the following vari- ables to help predict betas:

1. Variance of earnings.

2. Variance of cash flow.

3. Growth in earnings per share.

4. Market capitalization (firm size).

5. Dividend yield.