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Revisiting Total Beta

While thousands of pages have been written by academia and practitioners about common ordinary Beta, little has been written about Total Beta. Extant writing on Total Beta is, primarily, a good mix of confusion over: (1) what Beta is supposed to represent; (2) the proper use of statistical methods to construct it; and (3) whether or not we should include the risk related to undiversified investors (investor-specific risk) in the definition and calculation of Beta. This paper proposes to concentrate on these three central issues and demonstrate why Total Beta is not the resolution of any of them. Since an accurate critique of new theory/practice depends on a thorough grasp of traditional theory, we provide a basic “refresher course” in the foundational definitions and concepts underlying modern portfolio theory and statistics that pertain to Beta. We then seek to understand the derivation and meaning of Total Beta, as presented in the literature, and offer a rigorous critique that will enable the reader to properly assess this concept, its relevance and usefulness.