Betas and the Myth of Market Neutrality
27 Pages Posted: 20 Dec 2011 Last revised: 14 Dec 2012
Date Written: November 25, 2011
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: Suggested Citation