The Volatility Puzzle of the Low-Risk Anomaly

48 Pages Posted: 12 Jul 2021 Last revised: 11 Oct 2021

See all articles by Pedro Barroso

Pedro Barroso

CATÓLICA-LISBON School of Business & Economics

Andrew L. Detzel

Baylor University - Hankamer School of Business

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics

Date Written: June 27, 2021

Abstract

This paper shows that leading theories of the low-risk anomaly fail to provide a complete explanation for the anomaly’s conditional performance. Sharpe ratios and abnormal returns of betting-against-beta (BAB) and -idiosyncratic volatility (BAV) factors rise significantly following low volatility months, even when controlling for lottery preferences, and in the case of BAB, also controlling for mispricing and limits to arbitrage. Moreover, the leverage constraints theory counterfactually predicts that market and BAB Sharpe ratios increase with volatility. We also show that highly active institutions shift from high- to low-beta stocks as volatility increases, suggesting their demand contributes to the performance of BAB.

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

JEL Classification: G11, G12, G17

Suggested Citation

Barroso, Pedro and Detzel, Andrew L. and Maio, Paulo F., The Volatility Puzzle of the Low-Risk Anomaly (June 27, 2021). Available at SSRN: https://ssrn.com/abstract=3882108 or http://dx.doi.org/10.2139/ssrn.3882108

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

Baylor University - Hankamer School of Business ( email )

Waco, TX 76798
United States

HOME PAGE: http://andrewdetzel.com

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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