What is the implication of using historical returns to estimate beta?

Using historical returns to estimate beta can result in distorted and unreliable beta estimates because it relies on past performance to gauge future risk and correlation with market movements. Beta measures a stock's volatility in relation to the overall market; however, market conditions change over time, and past returns may not accurately reflect future volatility or risk. Factors such as changes in company fundamentals, industry dynamics, economic conditions, and market sentiment can significantly influence stock performance, making historical data potentially misleading.

While historical returns provide insights into how a stock has behaved in relation to the market, they do not account for changes that might occur in the future. Consequently, relying solely on this method for beta estimation can lead to misinformed investment decisions and an inaccurate assessment of a stock's risk profile.