Systematic Risk and Share Turnover

Abstract

This paper documents a simple and powerful cross-sectional mechanism: a higher rate of Investor participation in a stock translates into a greater contribution of the stock to market movements. The participation-driven overreaction (1) forms a persistent source of excess market volatility and, by implication, return predictability, (2) introduces a strong mechanical element into the beta-return relation, making this relation conditional on market state and challenging the meaningfulness of traditional tests of the CAPM, and (3) suggests that the low-risk anomaly (Black et al. (1972)) reflects a reversal of overreaction in the cross-section of stock returns. The endogeneity of market beta challenges the mainstream interpretation of the systematic risk-return relation and the notion of risk-adjusted returns in the finance literature.

Keywords: Market volatility, Short- and long-horizon betas, Parallel response to common shocks, Crowded-trade problem, Endogenous beta, Low-risk anomaly, Risk-return relation

JEL Classification: G12