Managing the Risk of the Beta Anomaly
43 Pages Posted: 29 Nov 2016 Last revised: 28 Jun 2021
Date Written: June 27, 2021
Betting-against-beta (BAB) portfolios produce large CAPM alphas. But these abnormal returns are well explained by equity factors. Operating profitability, investment, and momentum factors subsume the low-beta anomaly. However, volatility-managed versions of the same low-beta portfolios are more puzzling. Volatility management increases Sharpe ratios and risk-adjusted returns for all BAB portfolios. Splitting the sample by lagged volatility, the average Sharpe ratio of BAB portfolios increases from 0.28 after risky months to 1.32 after safe months. By splitting the total variance of each BAB portfolio into systematic and idiosyncratic components, the latter drives the gains of timing volatility.
Keywords: Betting-against-beta, time-varying risk, realized volatility, risk factors, scaled factors, market anomalies
JEL Classification: G11, G12, G17
Suggested Citation: Suggested Citation