CHAPTER 12

Unlevering and Levering Equity Betas1

INTRODUCTION

Published and calculated betas for publicly traded stocks typically reflect the capital structure of each respective company. These betas are sometimes referred to as levered betas, that is, betas reflecting the leverage in the company's capital structure.

Levered betas incorporate two risk factors that bear on systematic risk: business (or operating) risk and financial (or capital structure) risk. Removing the effect of financial leverage (i.e., unlevering the beta) leaves the effect of business risk only. The unlevered beta is often called an asset beta. Asset beta is the beta that would be expected were the company financed only with equity capital. When a firm's beta estimate is measured based on observed historical total returns (as most beta estimates are), its measurement necessarily includes volatility related to the company's financial risk. In particular, the equity of companies with higher levels of debt is riskier than the equity of ...

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