Economic Uncertainty and the Beta Anomaly

Abstract

Using various indices of economic uncertainty, we document a new stylized fact about the beta anomaly: while the beta-alpha relation is robustly negative following low economic uncertainty, it is insignificant following high economic uncertainty. We argue that this result arises because demand for high-beta stocks varies with economic uncertainty due to investors' ambiguity aversion and uncertainty-dependent risk aversion. Consistent with this argument, when uncertainty is high, mutual fund investors chase low-beta funds, and actively-managed mutual funds exchange high-beta stocks for low-beta ones. Accordingly, unexpected rises in economic uncertainty are associated with poorer performance of high-beta stocks relative to low-beta stocks, which helps to make the subsequent stock returns more in line with betas.

Keywords: Economic uncertainty; ambiguity aversion; asset pricing anomaly; idiosyncratic volatility; mutual fund; stock return

JEL Classification: G12; G14