How is the effective beta calculated in portfolio management?

The effective beta in portfolio management is calculated as the ratio of the portfolio return to the market return. This method captures how a portfolio's returns respond to market movements, showing the sensitivity of the portfolio to changes in the overall market. By considering both the returns of the portfolio and the market, this approach provides a clear indicator of the portfolio’s systematic risk relative to the market itself.

When evaluating performance and risk, understanding effective beta is crucial because it helps in determining how much risk a portfolio is exposed to in relation to market movements. It can also assist asset managers in making informed decisions about asset allocation, risk management, and the expected performance of the portfolio under different market conditions.

In this context, the other options do not accurately reflect the calculation of effective beta: they do not establish the relationship between portfolio returns and market returns, which is essential for quantifying market risk exposure through beta.