Question on Beta
So I have a question that I can't quite seem to figure out. I'm sure I'm missing something trivial but bare with me.
Lets say you have two factories - Factory A, which is in a normal weather area, and Factory B, which is in a hurricane area. How do the beta's of these two companies compare?
Now, given that beta measures SYSTEMATIC risk and a hurricane would be an unsystematic risk for Factory B, the beta's should not be effected. However, given that the numerator on beta is the covariance between return of asset and return of market, shouldn't beta be effected? I know that the return on market in this situation will not change, so the covariance will be 0, but from a statistical point of view this should still effect the beta of Factory B.
What am I missing/fucking up?
Beta only measures non-diversifiable market risk. The hurricane can be diversified by factory B by say, building a second factory somewhere else. Because the risk presented by the hurricane can be diversified, it has no beta
Why wouldn't a hurricane be a systematic risk? I'm pretty sure they represent a large enough capital shock to have a system wide effect
Well lets assume for the sake of argument that its not a systematic risk.
I understand that the beta of Factory B can be "diversified away" and I'm fully familiar with the definition of beta - I know the answer is that it's unaffected but it still isn't clear to me why the beta of Factory B would be unaffected given its formula with respect to the numerator.
In the real world, creditors and equity investors would require the firm to keep a reserve in case of 'an act of god' or such. This would add an environmental liability to the balance sheet and therefore, increasing the levered beta.
Factory A and B, would have the same unlevered beta, because beta is just a correlation with some index (and when there is no debt, they are the same, ceteris parabus).
Also, in the long run, the beta will also be higher assuming losses occur which are uncorrelated with the market.
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