Market neutrality and beta crashes

Xia Xu

Journal of Empirical Finance, 2025, vol. 80, issue C

Abstract: Market neutrality is a key feature of Frazzini and Pedersen (2014)’s betting-against-beta (BAB) factor. However, we find that BAB fails to remain market neutral in practice, and the deviations from market neutrality often arrive in the shape of crashes. BAB resembles momentum in terms of option-like payoffs, exhibiting significant exposure to large market movements. Particularly, BAB effectuates negative market timing and negative volatility timing amid volatile markets, promoting BAB crashes. The concern of imperfect market neutrality is shared by a broad range of beta arbitrage strategies that are aimed at being market neutral. The strategy’s vulnerability to bull markets is not fundamentally explained by the liquidity and leverage rationale. Managing beta crashes significantly improves investment performance.

Keywords: Betting against beta; Market neutrality; Low-beta anomaly (search for similar items in EconPapers)
JEL-codes: G10 G11 G12 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:80:y:2025:i:c:s0927539824001117

DOI: 10.1016/j.jempfin.2024.101577

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