Managing the risk of the low risk anomaly

54 Pages Posted: 29 Nov 2016 Last revised: 16 Jun 2020

See all articles by Pedro Barroso

Pedro Barroso

CATÓLICA-LISBON School of Business & Economics

Andrew L. Detzel

University of Denver - Daniels College of Business

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics

Date Written: June 16, 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 increases risk-adjusted returns for all BAR portfolios. Splitting the sample by lagged volatility, risk factors explain returns only after months of high volatility. All BAR long-short portfolios earn abnormal profits following low-volatility months. By splitting the total variance of each BAR factor into systematic and idiosyncratic components, the later drives the gains of timing risk. The negative predictive relation of volatility and BAR profitability is hard to reconcile with leverage constraints and lottery demand, the leading extant theories of low-risk effects.

Keywords: Betting-against-beta, time-varying risk, realized volatility, scaled factors, market anomalies, lotteries, leverage constraints

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 (June 16, 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)

CATÓLICA-LISBON School of Business & Economics ( email )

Palma de Cima
Lisbon, Lisboa 1649-023
Portugal

HOME PAGE: http://https://clsbe.lisboa.ucp.pt/person/pedro-monteiro-e-silva-barroso

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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