Question

Suppose you are trying to estimate the equity beta of a pink sheet stock using daily data. Pink sheets are stocks with tiny market capitalizations (sometimes called “microcaps” or “nanocaps”) that trade infrequently in over-the-counter markets and not on exchanges. Explain why your beta estimate is likely biased, and how.

Answer 1

Pink sheets are stocks which are traded via Over The Counter (OTC). Pink sheet includes companies which are not listed on any major exchange like NSE or Nasdaq. The majority of stocks are low priced penny stocks i.e. they are traded for less than $5 per share.

Beta is the sensitivity of share price of a company with respect to market. The primary reason why the beta will be biased is because there is very less information & regulatory oversight which largely affects the data which lead to the calculation of beta. Due to lack of any stable variable (no Index) the calculation of beta is highly dependent on the speculative prowess of the individual. Along with lack of stable index, pink sheet listings usually consists of companie which do not need to file required documentation with SEC. Due to lack of financial information it becomes very difficult to assess the financial condition of the companies, hence leading to increased volatility and a fluctuating beta.

How beta will be affected:

1. Index information is highly self assessed and not certified.

2. Financial information of companies is difficult to find.

Both these factors are critical in calculation of beta which will lead to a biased beta.