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The volatility puzzle of the beta anomaly

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  • Barroso, Pedro
  • Detzel, Andrew
  • Maio, Paulo

Abstract

This paper shows that leading theories of the beta anomaly fail to explain the anomaly’s conditional performance. Abnormal returns and Sharpe ratios of betting-against-beta (BAB) factors rise following months with below-median realized volatility, even controlling for mispricing, limits to arbitrage, lottery preferences, analyst disagreement, and sentiment. Moreover, the leverage constraints theory counterfactually predicts that market and BAB Sharpe ratios increase with volatility. We further show that institutional investors shift their demand from high- to low-beta stocks as volatility increases, and the resulting price impact is sufficient to explain the difference in abnormal BAB returns between high- and low-volatility states.

Suggested Citation

  • Barroso, Pedro & Detzel, Andrew & Maio, Paulo, 2025. "The volatility puzzle of the beta anomaly," Journal of Financial Economics, Elsevier, vol. 165(C).
    • Handle: RePEc:eee:jfinec:v:165:y:2025:i:c:s0304405x25000029
    DOI: 10.1016/j.jfineco.2025.103994
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    Keywords

    Betting-against-beta; Time-varying risk; Realized volatility; Risk factors; Scaled factors; Anomalies; Lottery preferences; Leverage constraints;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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