Investor Betas *

53 Pages Posted: 28 Jan 2021 Last revised: 15 Jul 2024

See all articles by Lorenzo Bretscher

Lorenzo Bretscher

Swiss Finance Institute - HEC Lausanne; Centre for Economic Policy Research (CEPR)

Ryan Lewis

University of Colorado, Boulder

Shrihari Santosh

University of Colorado at Boulder - Department of Finance; University of Maryland - R.H. Smith School of Business

Date Written: November 1, 2020

Abstract

We provide novel evidence that asset prices reflect covariance risk when betas are measured against institutional investor portfolios. Leveraging the insights of Markowitz (1952), we propose a simple model of holding constrained investors that generates the following prediction: an asset's expected return is linear in its beta with respect to each investor's portfolio return, averaged across institutions that hold the asset. Empirically, a unit increase in this "investor beta" measure commands 5-8% greater annual expected returns in equity markets with a cross-sectional R 2 of approximately 80-90% in test portfolios. We observe a similar investor beta-returns relationship in the bond market where the return increase per unit of investor beta risk is over 100bps. Betas measured from the perspective of otherwise similar institutions that choose not to hold a particular asset are uncorrelated with returns. Based on our results, we calculate that lack of diversification can explain 20-30% of the equity risk premium.

Keywords: CAPM, risk, return, idiosyncratic, portfolio, active, investor

JEL Classification: G11, G12

Suggested Citation

Bretscher, Lorenzo and Lewis, Ryan and Santosh, Shrihari, Investor Betas * (November 1, 2020). Available at SSRN: https://ssrn.com/abstract=3739424 or http://dx.doi.org/10.2139/ssrn.3739424

Lorenzo Bretscher

Swiss Finance Institute - HEC Lausanne ( email )

Chavannes-près-Renens, Vaud
Switzerland
1015 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Ryan Lewis (Contact Author)

University of Colorado, Boulder ( email )

Boulder, CO 80309-0419
United States

Shrihari Santosh

University of Colorado at Boulder - Department of Finance ( email )

Campus Box 419
Boulder, CO 80309
United States

University of Maryland - R.H. Smith School of Business ( email )

Robert H. Smith School of Business
Van Munching Hall
College Park, MD 20742
United States

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