The Booms and Busts of Beta Arbitrage

53 Pages Posted: 29 Sep 2015

See all articles by Shiyang Huang

Shiyang Huang

The University of Hong Kong - School of Economics and Finance

Dong Lou

London School of Economics & Political Science (LSE); Centre for Economic Policy Research (CEPR)

Christopher Polk

London School of Economics

Date Written: August 2015

Abstract

Low-beta stocks deliver high average returns and low risk relative to high-beta stocks, an opportunity for professional investors to “arbitrage” away. We argue that beta arbitrage activity instead generates booms and busts in the strategy’s abnormal trading profits. In times of low activity, the beta-arbitrage strategy exhibits delayed correction, taking up to three years for abnormal returns to be realized. In stark contrast, when activity is high, prices overshoot as short-run abnormal returns are much larger and then revert in the long run. We document a novel positive-feedback channel operating through firm-level leverage that facilitates these boom and bust cycles.

Keywords: beta arbitrage, booms and busts, positive-feedback

JEL Classification: G14, G31

Suggested Citation

Huang, Shiyang and Lou, Dong and Polk, Christopher, The Booms and Busts of Beta Arbitrage (August 2015). Finance Down Under 2016 Building on the Best from the Cellars of Finance. Available at SSRN: https://ssrn.com/abstract=2666910 or http://dx.doi.org/10.2139/ssrn.2666910

Shiyang Huang (Contact Author)

The University of Hong Kong - School of Economics and Finance ( email )

8th Floor Kennedy Town Centre
23 Belcher's Street
Kennedy Town
Hong Kong

Dong Lou

London School of Economics & Political Science (LSE) ( email )

Department of Finance
Houghton Street
London, WC2A 2AE
United Kingdom
+44 (0)207 1075360 (Phone)

HOME PAGE: http://personal.lse.ac.uk/loud/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Christopher Polk

London School of Economics ( email )

United Kingdom

HOME PAGE: http://personal.lse.ac.uk/polk/

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