Systematic Risk and Share Turnover [or Beta as a Measure of Mispricing]

Abstract

This paper documents a simple and powerful cross-sectional mechanism: a higher rate of investor participation in trading a stock translates into a greater contribution of the stock to market movements. The participation-driven overreaction (1) forms a persistent source of excess market volatility and, by implication, return predictability, (2) introduces a strong mechanical element into the beta-return relation, making this relation conditional on market state and challenging the meaningfulness of traditional tests of the CAPM, and (3) suggests that the low-risk anomaly (Black et al. (1972)) reflects a reversal of overreaction in the cross-section of stock returns. The endogeneity of market beta challenges the mainstream interpretation of the systematic risk-return relation and the notion of risk-adjusted returns in the finance literature.