Asset Pricing Anomalies and the Low-Risk Puzzle

Abstract

The observation that low-risk assets on average have higher risk-adjusted returns relative to high-risk assets – the low-risk effect – is a driving force behind a broad set of well-documented cross-sectional asset pricing anomalies. I document that long-short strategies formed on a wide range of anomaly characteristics tend to buy low-risk and short high-risk assets. I show that this tendency implicitly embeds the low-risk effect in these cross-sectional long-short portfolios. Taking into account the exposure to the low-risk effect attenuates the economic and statistical significance of the risk-adjusted returns to a large set of asset pricing anomalies.

Keywords: Low-risk effect, cross-sectional stock returns, beta anomaly, volatility anomaly

JEL Classification: G12