Why the Low Volatility Anomaly Will Persist

31 Pages Posted: 13 Dec 2014 Last revised: 24 Dec 2016

Eric G. Falkenstein

Pine River Capital Management

Date Written: December 23, 2016

Abstract

Common explanations of the low volatility anomaly involve biases or frictions that cause investors to overpay for high volatility assets, giving them a negative alpha within the CAPM model, yet currently all such mechanisms are either heuristic or partial equilibrium. This paper shows that leverage constraints of Frazzini and Pedersen (2014) alone cannot explain this result if there also exist rational investors. If 3 non-standard assumptions are added — hybrid relative utility, delusional subset of investors, residual systematic risk across beta — then we can capture several facts existing models cannot simultaneously capture: a positive return to the market, positive holdings by rational investors to negative CAPM-alpha stocks, and a negative Security Market Line. New data relevant to these assumptions are presented.

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

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

Suggested Citation

Falkenstein, Eric G., Why the Low Volatility Anomaly Will Persist (December 23, 2016). Available at SSRN: https://ssrn.com/abstract=2537050 or http://dx.doi.org/10.2139/ssrn.2537050

Eric G. Falkenstein (Contact Author)

Pine River Capital Management ( email )

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

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