Beta Risk in the Cross-Section of Equities
86 Pages Posted: 3 Mar 2017
Date Written: December 23, 2017
We develop a conditional capital asset pricing model in continuous-time that allows for stochastic beta exposure. When beta co-moves with market variance and the stochastic discount factor (SDF), beta risk is priced, and the expected return on a stock deviates from the security market line. The model predicts that low-beta stocks earn high returns because their beta co-moves positively with market variance and the SDF. The opposite is true for high-beta stocks. Estimating the model on equity and option data, we find that beta risk explains expected returns on low- and high-beta stocks, resolving the "betting against beta" anomaly.
Keywords: Factor models, stochastic beta, option-implied beta, Wishart processes
JEL Classification: G10, G12, G13
Suggested Citation: Suggested Citation