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Enhancing betting against beta with stochastic dominance

Author

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  • Kolokolova, Olga
  • Xu, Xia

Abstract

The performance of the widely used betting-against-beta (BAB) investment strategy is improved by controlling for the stochastic dominance (SD) relation between individual stocks and the market portfolio. Dominating stocks, preferred by all risk-averse and prudent investors, are excluded from the short leg of the BAB strategy. Stocks that are dominated by the market are excluded from the long leg of the strategy. This prefiltering significantly enhances a wide range of performance and risk measures including abnormal returns relative to various factor models. The improvements are especially pronounced for the third-order SD, are robust to transaction costs and different market conditions.

Suggested Citation

  • Kolokolova, Olga & Xu, Xia, 2024. "Enhancing betting against beta with stochastic dominance," Journal of Empirical Finance, Elsevier, vol. 76(C).
    • Handle: RePEc:eee:empfin:v:76:y:2024:i:c:s0927539823001329
    DOI: 10.1016/j.jempfin.2023.101465
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    More about this item

    Keywords

    Stochastic dominance; Market beta; Beta arbitrage; Betting against beta;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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