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Volatility and Compounding Effects on Beta and Returns

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  • William J. Trainor

Abstract

Previous research indicates that long-term investors are not compensated for beta or volatility risk. This study shows these two results are at least partly due to the mathematics of compounding exacerbated in high volatility markets. Theoretical beta portfolios defined to perform exactly as the Capital Asset Pricing Model (CAPM) would predict on a monthly basis, show that high beta portfolios dramatically outperform in low volatility environments and underperform in high volatility environments. Empirically sorted beta portfolios confirm the results and show in a low volatility environment, high beta portfolios outperform low beta portfolios by 0.42% a month and underperform by 0.51% in high volatility environments. When combining the two market environments, the inevitable result shows no relationship between beta and return.

Suggested Citation

  • William J. Trainor, 2012. "Volatility and Compounding Effects on Beta and Returns," The International Journal of Business and Finance Research, The Institute for Business and Finance Research, vol. 6(4), pages 1-11.
    • Handle: RePEc:ibf:ijbfre:v:6:y:2012:i:4:p:1-11
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    References listed on IDEAS

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    5. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross‐Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 259-299, February.
    6. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    7. Benoit Mandelbrot, 2015. "The Variation of Certain Speculative Prices," World Scientific Book Chapters, in: Anastasios G Malliaris & William T Ziemba (ed.), THE WORLD SCIENTIFIC HANDBOOK OF FUTURES MARKETS, chapter 3, pages 39-78, World Scientific Publishing Co. Pte. Ltd..
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    Cited by:

    1. Chung-Han Hsieh & Jow-Ran Chang & Hui Hsiang Chen, 2025. "Compounding Effects in Leveraged ETFs: Beyond the Volatility Drag Paradigm," Papers 2504.20116, arXiv.org.

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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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