Explanations for the Volatility Effect: An Overview Based on the CAPM Assumptions

26 Pages Posted: 28 May 2013 Last revised: 11 Jun 2013

David Blitz

Robeco Asset Management - Quantitative Strategies

Eric G. Falkenstein

Pine River Capital Management

Pim van Vliet

Robeco Asset Management - Quantitative Strategies

Multiple version iconThere are 2 versions of this paper

Date Written: May 28, 2013

Abstract

The Capital Asset Pricing Model (CAPM) predicts a positive relation between risk and return, but empirical studies find the actual relation to be flat, or even negative. This paper provides a broad overview of explanations for this ‘volatility effect’ that have been proposed in different streams of literature, and categorizes each explanation according to the CAPM assumption it relates to. Interestingly, various explanations relate to investor behavior that is rational given exogenous incentive structures or constraints, which may explain why the volatility effect has been so persistent over time. We argue that although the CAPM may be bad at explaining reality, addressing the reasons for its failure could actually be a normative arbitrage opportunity.

Keywords: volatility effect, anomaly, CAPM, arbitrage, asset pricing, agency effects, behavioral finance, low-beta anomaly

JEL Classification: F20, G11, G12, G14, G15

Suggested Citation

Blitz, David and Falkenstein, Eric G. and van Vliet, Pim, Explanations for the Volatility Effect: An Overview Based on the CAPM Assumptions (May 28, 2013). Available at SSRN: https://ssrn.com/abstract=2270973 or http://dx.doi.org/10.2139/ssrn.2270973

David Blitz (Contact Author)

Robeco Asset Management - Quantitative Strategies ( email )

Weena 850
Rotterdam, 3014 DA
Netherlands

Eric G. Falkenstein

Pine River Capital Management ( email )

601 Calson Parkway, Suite 330
Minnetonka, MN 55347
United States
6123091588 (Phone)
6123091588 (Fax)

Pim Van Vliet

Robeco Asset Management - Quantitative Strategies ( email )

Rotterdam, 3011 AG
Netherlands

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