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Why Negative-Beta Assets Can Have Returns Below the Risk-Free Rate

Article Quant Q&A · Author: Layne
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Summary

The note explains how CAPM can assign a required return below the risk-free rate to a volatile asset with negative beta. The apparent puzzle is resolved by considering the asset’s effect on the investor’s overall portfolio: it can provide insurance against adverse macroeconomic outcomes that hurt other holdings. A risk-averse investor may accept a lower expected return in exchange for that hedge.

Gold is offered as an example of a potential inflation hedge, while stock put options and short index forwards are cited as other positions that may have negative beta. These examples illustrate the portfolio-protection idea rather than establish that the assets always have negative beta. The note gives no derivation or empirical evidence, and the explanation depends on the hedge reducing relevant portfolio risk under the CAPM setting.

Key ideas

  • A negative-beta asset can have a CAPM required return below the risk-free rate.
  • An investor may accept lower expected return when an asset insures against risks affecting the rest of the portfolio.
  • Gold, stock put options, and short index forwards are cited as possible negative-beta hedges.
  • Whether an asset provides this protection depends on its relationship to the portfolio’s macroeconomic risks.

Tags

StatisticsRisk managementOptions
Full text
# Negative Beta and CAPM


# Negative Beta and CAPM












In the case of a stock with negative beta and non-zero volatility, under CAPM the required return is less than the risk-free rate. This seems contradictory under CAPM assumptions that investors are rational/risk-averse and can invest unlimited amounts at the risk-free rate.

How should required returns less than the risk-free rate be interpreted? Why would a risk-averse investor purchase a stock with less return than the risk-free rate?

## Answer by develarist (score 2)

https://quant.stackexchange.com/a/49918

A negative beta investment whose expected return is less than the risk-free rate represents insurance against some macroeconomic risk that adversely affects the rest of the portfolio, therefore, making such a position aligned with the interests of risk-averse investors. Gold is a standard example of a negative beta investment because it acts as a hedge against higher inflation, which ruins financial investments such as stocks and bonds. Put options on stocks and selling forward contracts against indices may likewise have negative betas.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.