Betting Against Beta: Building a Beta-Neutral Equity Factor
Summary
The document explains the betting-against-beta (BAB) factor and its proposed cause: investors with leverage or margin limits may bid up high-beta stocks to pursue higher returns, depressing their future risk-adjusted performance. Investors able to use leverage can seek to exploit this by holding low-beta stocks with leverage and shorting high-beta stocks with reduced exposure, scaling both sides to beta one.
Its example ranks CRSP stocks by beta estimated against a US equity index over a rolling one-year window, forms low- and high-beta portfolios, and rebalances monthly. The source-paper summary reports positive risk-adjusted BAB returns across several markets, while related studies discuss industry-neutral results and applications beyond stocks. The document cautions that costs and slippage matter, the effect may be strongest in small-cap stocks, and crowded demand can leave low-beta shares expensive and vulnerable in market stress. It gives no implementation cost estimates or independent out-of-sample results for the described example.
Key ideas
- Leverage constraints may lead some investors to favor high-beta stocks, potentially lowering their risk-adjusted returns.
- A BAB portfolio buys leveraged low-beta stocks and shorts high-beta stocks with exposure adjusted toward beta neutrality.
- The example estimates stock betas on a rolling one-year window and rebalances the portfolios monthly.
- Transaction costs, slippage, small-cap exposure, and crowded low-beta valuations can affect results.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.