Betting Against (Bad) Beta

Abstract

Frazzini and Pedersen (2014) Betting Against Beta (BAB) factor is based on the idea that high beta assets trade at a premium and low beta assets trade at a discount due to investor funding constraints. However, as argued by Campbell and Vuolteenaho (2004) beta comes in "good" and "bad" varieties. While gaining exposure to lowbeta, BAB factors fail to recognize that such a portfolio may tilt towards bad-beta. We propose a Betting Against Bad Beta factor, built by double-sorting on beta and bad-beta and find that it improves the overall performance of BAB strategies though its success relies on proper transaction cost mitigation.

Keywords: Betting Against Beta, Asset Pricing, Factor Models

JEL Classification: G12, G14, G11