The Booms and Busts of Beta Arbitrage

Christopher Polk, Dong Lou and Shiyang Huang

No 11531, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Low-beta stocks deliver high average returns and low risk relative to high-beta stocks, an opportunity for professional investors to “arbitrage†away. We argue that beta-arbitrage activity instead generates booms and busts in the strategy’s abnormal trading profits. In times of low activity, the beta-arbitrage strategy exhibits delayed correction, taking up to three years for abnormal returns to be realized. In stark contrast, when activity is high, prices overshoot as short-run abnormal returns are much larger and then revert in the long run. These cyclical patterns also show up in hedge fund exposures to beta arbitrage, particularly exposures of smaller and thus more nimble funds, and can be linked to the past performance of the strategy. We document a novel positive-feedback channel operating through firm-level leverage that facilitates these boom and bust cycles.

Keywords: Betting against beta; Positive-feedback trading; Crowded trades (search for similar items in EconPapers)
JEL-codes: G02 G12 G14 G23 (search for similar items in EconPapers)
Date: 2016-09
New Economics Papers: this item is included in nep-bec and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Related works:
Journal Article: The Booms and Busts of Beta Arbitrage (2024)
Working Paper: The booms and busts of beta arbitrage (2023)
Working Paper: The booms and busts of beta arbitrage (2014)
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