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Underconfidence, Pessimism and the Low-Beta Anomaly

59 Pages Posted: 11 Feb 2002 Last revised: 15 Sep 2017

Soosung Hwang

Sungkyunkwan University - Department of Economics

Mark Salmon

University of Cambridge - Faculty of Economics and Politics

Date Written: February 27, 2017

Abstract

We investigate the effects of behavioral biases on asset returns using the concept of beta herding that measures the cross-sectional shrinkage in betas induced by investors’ sentiment and overconfidence about the overall market outlook. Beta herding becomes apparent when investors are optimistic or overconfident regarding the future direction of the market whereas adverse beta herding arises (the dispersion of betas increases) once a crisis appears and uncertainty increases. It is following adverse beta herding periods when high beta stocks underperform low beta stocks, and thus the low beta anomaly disappears when adverse beta herding is considered. We demonstrate that the effects of beta herding on beta-sorted portfolios are different from those of sentiment, and that the effects are quite persistent, lasting more than two years.

Keywords: Beta, Herding, Overconfidence, Sentiment, Market Crises, Low-beta Anomaly

JEL Classification: C12, C31, G12, G14

Suggested Citation

Hwang, Soosung and Salmon, Mark, Underconfidence, Pessimism and the Low-Beta Anomaly (February 27, 2017). Available at SSRN: https://ssrn.com/abstract=299919 or http://dx.doi.org/10.2139/ssrn.299919

Soosung Hwang (Contact Author)

Sungkyunkwan University - Department of Economics ( email )

25-2 Sungkyunkwan-ro
Jongno-Gu
110-745 Seoul
+82 (0)2 760 0489 (Phone)
+82 (0)2 744 5717 (Fax)

Mark Howard Salmon

University of Cambridge - Faculty of Economics and Politics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

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