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Betas and the Myth of Market Neutrality

27 Pages Posted: 20 Dec 2011 Last revised: 14 Dec 2012

Nicolas A. Papageorgiou

HEC Montreal - Department of Finance

Jonathan J. Reeves

UNSW Business School, University of New South Wales; Financial Research Network (FIRN)

Xuan Xie

Commonwealth Bank of Australia

Date Written: November 25, 2011

Abstract

Market neutral funds are commonly advertised as alternative investments offering returns which are uncorrelated with the broad market. Utilizing recent advances in financial econometrics we demonstrate that constructing market (beta) neutral funds by standard forecasting methods is often very inaccurate. Our findings demonstrate that commonly employed econometric methods to forecast beta (systematic) risk typically lack sufficient accuracy to permit the successful construction of market neutral portfolios. The results in this paper also highlight the need for higher frequency return data to be more commonly utilized. We demonstrate an approach using daily returns over the past year that is easy to implement and delivers a substantial improvement, relative to other methods, when attempting to construct a market neutral portfolio.

Keywords: realized beta, zero-beta portfolios, forecasting

JEL Classification: C52, C53, G17

Suggested Citation

Papageorgiou, Nicolas A. and Reeves, Jonathan J. and Xie, Xuan, Betas and the Myth of Market Neutrality (November 25, 2011). Available at SSRN: https://ssrn.com/abstract=1974370 or http://dx.doi.org/10.2139/ssrn.1974370

Nicolas A. Papageorgiou

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

Jonathan J. Reeves (Contact Author)

UNSW Business School, University of New South Wales ( email )

Sydney, NSW 2052
Australia

Financial Research Network (FIRN) ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

Xuan Xie

Commonwealth Bank of Australia ( email )

Sydney, NSW 2052
Australia

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