Managing the Risk of the Low-Risk Anomaly

55 Pages Posted: 29 Nov 2016 Last revised: 5 Feb 2020

See all articles by Pedro Barroso

Pedro Barroso

UNSW Australia Business School, School of Banking and Finance

Andrew L. Detzel

University of Denver - Daniels College of Business

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics

Date Written: February 3, 2020

Abstract

Betting-against-risk (BAR) anomaly portfolios formed on past beta and idiosyncratic/total volatility produce large CAPM alphas. But these return spreads are well explained by the Fama--French six-factor model (FF6). Operating profitability, investment, and momentum factors subsume the low-risk anomaly. However, risk-managed versions of the same low-risk anomalies are substantially more puzzling. Specifically, risk management increases the Sharpe ratio in 29 out of 30 cases examined and significantly increases the risk-adjusted returns for all BAR portfolios. Splitting the sample by lagged volatility, it follows that the risk factors in FF6 explain low-risk anomalies only after months of high volatility---exactly those periods when the anomaly is weak. Indeed, all BAR long-short portfolios earn significant abnormal profits following low-volatility months. By splitting the total variance of each low-risk factor, into systematic and idiosyncratic components, the later drives the gains of timing risk. Our results suggest that risk management resurrects the low-risk anomaly.

Keywords: Betting-against-beta, BAB, time-varying risk, momentum, realized volatility, risk factors, scaled factors, market anomalies

JEL Classification: G11, G12, G17

Suggested Citation

Barroso, Pedro and Detzel, Andrew L. and Maio, Paulo F., Managing the Risk of the Low-Risk Anomaly (February 3, 2020). 30th Australasian Finance and Banking Conference 2017. Available at SSRN: https://ssrn.com/abstract=2876450 or http://dx.doi.org/10.2139/ssrn.2876450

Pedro Barroso (Contact Author)

UNSW Australia Business School, School of Banking and Finance ( email )

Sydney, NSW 2052
Australia

Andrew L. Detzel

University of Denver - Daniels College of Business ( email )

2101 S. University Blvd
Denver, CO 80208
United States

HOME PAGE: http://portfolio.du.edu/adetzel

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics ( email )

FI-00101 Helsinki
Finland

HOME PAGE: http://sites.google.com/site/paulofmaio/home

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