A Behavioral Finance Explanation for the Success of Low Volatility Portfolios

22 Pages Posted: 26 Jun 2013

See all articles by Malcolm P. Baker

Malcolm P. Baker

Harvard Business School; National Bureau of Economic Research (NBER)

Jeffrey Wurgler

NYU Stern School of Business; National Bureau of Economic Research (NBER)

Brendan Bradley

Acadian Asset Management Inc., USA

Multiple version iconThere are 3 versions of this paper

Date Written: January 2010

Abstract

Arguably the most remarkable anomaly in finance is the violation of the risk‐return tradeoff within the stock market: Over the past 40 years, high volatility and high beta stocks in U.S. markets have substantially underperformed low volatility and low beta stocks. We propose an explanation that combines the average investor's preference for risk and the typical institutional investor's mandate to maximize the ratio of excess returns to tracking error relative to a fixed benchmark (the information ratio) rather than the Sharpe ratio. Models of delegated asset management show that such mandates discourage arbitrage activity in both high alpha, low beta stocks and low alpha, high beta stocks. This explanation is consistent with several aspects of the low volatility anomaly including why it has only strengthened even as institutional investors have become more numerous.

Suggested Citation

Baker, Malcolm P. and Wurgler, Jeffrey A. and Bradley, Brendan, A Behavioral Finance Explanation for the Success of Low Volatility Portfolios (January 2010). NYU Working Paper No. 2451/29537. Available at SSRN: https://ssrn.com/abstract=2284643

Malcolm P. Baker

Harvard Business School ( email )

Boston, MA 02163
United States
617-495-6566 (Phone)

HOME PAGE: http://www.people.hbs.edu/mbaker

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jeffrey A. Wurgler (Contact Author)

NYU Stern School of Business ( email )

Stern School of Business
44 West 4th Street, Suite 9-190
New York, NY 10012-1126
United States
212-998-0367 (Phone)
212-995-4233 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~jwurgler/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Brendan Bradley

Acadian Asset Management Inc., USA ( email )

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