Systematic Risk and Share Turnover
49 Pages Posted: 27 Mar 2015 Last revised: 6 May 2015
Date Written: May 2, 2015
I show that the stocks’ contribution to market volatility increases uniformly with their share turnover. The source of this relation is the market force driving the persistence of cross-sectional variation in turnover, namely the rate of investor participation in a stock. A higher rate of participation generates a persistent pattern of relative overreaction to common shocks, resulting in a large cross-sectional dispersion in market beta at both short and long return horizons. This mechanism (i) sheds light on the source of excess market volatility, (ii) introduces a strong mechanical element into the beta-return relation, challenging the traditional interpretation of this relation and the meaningfulness of the existing tests of the CAPM, and (iii) suggests that the low-beta anomaly (Black et al., 1972) reflects a reversal of the beta-driven overreaction in the cross-section of stock returns.
Keywords: Market volatility; Short- and long-horizon betas; Parallel response to common shocks; Crowded-trade problem; Mechanical risk-return relation; Stylized empirical fact
JEL Classification: G12
Suggested Citation: Suggested Citation