The Booms and Busts of Beta Arbitrage

61 Pages Posted: 26 Sep 2016

See all articles by Shiyang Huang

Shiyang Huang

The University of Hong Kong - Faculty of Business and Economics

Dong Lou

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

Christopher Polk

London School of Economics

Date Written: September 2016

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. These cyclical patterns also show up in hedge fund exposures to beta arbitrage, particularly exposures of smaller and thus more nimble funds, and can be linked to the past performance of the strategy. We document a novel positive-feedback channel operating through firm-level leverage that facilitates these boom and bust cycles.

Keywords: betting against beta, crowded trades, positive-feedback trading

JEL Classification: G02, G12, G14, G23

Suggested Citation

Huang, Shiyang and Lou, Dong and Polk, Christopher, The Booms and Busts of Beta Arbitrage (September 2016). CEPR Discussion Paper No. DP11531. Available at SSRN: https://ssrn.com/abstract=2843570

Shiyang Huang (Contact Author)

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

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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