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Does It Pay to Bet Against Beta? On the Conditional Performance of the Beta Anomaly
Author(s) -
CEDERBURG SCOTT,
O'DOHERTY MICHAEL S.
Publication year - 2016
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12383
Subject(s) - capital asset pricing model , beta (programming language) , portfolio , economics , volatility (finance) , econometrics , financial economics , anomaly (physics) , equity (law) , computer science , physics , political science , law , programming language , condensed matter physics
Prior studies find that a strategy that buys high‐beta stocks and sells low‐beta stocks has a significantly negative unconditional capital asset pricing model (CAPM) alpha, such that it appears to pay to “bet against beta.” We show, however, that the conditional beta for the high‐minus‐low beta portfolio covaries negatively with the equity premium and positively with market volatility. As a result, the unconditional alpha is a downward‐biased estimate of the true alpha. We model the conditional market risk for beta‐sorted portfolios using instrumental variables methods and find that the conditional CAPM resolves the beta anomaly.