Economic Uncertainty and the Beta Anomaly

Abstract

Using various measures of economic uncertainty, we find that the beta-alpha anomaly exists only during periods of low economic uncertainty. We argue that diminished risk appetite during high economic uncertainty eases leverage constraints of typical long-only investors, making overvaluation of high-beta stocks less likely. Differences in uncertainty-related beta trading activities between mutual fund investors/managers and hedge funds support this explanation. Variation of the beta anomaly within the low-uncertainty state further corroborates it: The anomaly is more pronounced among stocks heavily held by investors who are more likely to be leverage constrained, and concentrated in the subperiods in which leverage constraints for typical long-only investors are likely to be more severe.

Keywords: Economic uncertainty; ambiguity aversion; asset pricing anomaly; leverage constraint, mutual fund, hedge fund

JEL Classification: G12; G14