A qualitative parameter for beta changes

In this study, we explore the ‘qualitative’ aspect of a stock using an innovative parameter known as b∗. We propose a method to construct two portfolios, DtU (Downside to Upside Risk) and UtD (Upside to Downside Risk), based on variations in the coefficient b∗ which we consider as a ‘qualitative’ parameter. Our analysis spans from January 1992 to July 2018, encompassing both the bullish period until the early 2000s and the 2008 financial crisis. We employ various models to investigate their effectiveness in capturing systematic risk within the portfolios’ constituents. While most models detect beta changes, their outcomes yield mixed results concerning the extent and direction of these changes, highlighting the challenge investors face in constructing beta-based portfolios. Additionally, our findings indicate that stocks in the DtU portfolio, exhibiting positive b∗ changes, demonstrate strong fundamentals, lower post-earnings announcement drift compared to UtD stocks, and a reduced arbitrage to explained risk (AR/ER) ratio. Notably, both DtU and UtD portfolios exhibit lower AR/ER ratios than previously documented in the literature. Finally, we evaluate the performance of an out-of-sample trading strategy designed to capture these ‘qualitative’ beta changes. Our results reveal positive and statistically significant risk-adjusted returns for the DtU portfolio, not adequately captured by recently proposed asset pricing models. These outcomes exhibit robustness across various analyses and checks.