THE LOW BETA ANOMALY: WHY LOW-BETA STOCKS OUTPERFORM HIGH-BETA ONES

Abstract

Recent empirical studies have shown that low-beta stocks dramatically outperform high-beta stocks. In this study, we examine whether this anomaly comes from any particular category of investors and if so, what the causes are. We also show the performance of low versus high-beta stocks after controlling for various factors, and document their long-run cumulative returns and alphas. We find that the low-beta stocks outperform high-beta ones from 1968 to 2012, and this outperformance can be explained by Carhart's momentum factor. Controlling for size and institutional ownership, our analyses show that the low beta anomaly is concentrated among stocks with lower market capitalization and lower institutional ownership, suggesting individual investors are driving the outperformance of low-beta stocks. Knowing that individual investors have a propensity to gamble, we investigate the relationship between lottery characteristics and beta, and find that MAX effect is the lottery feature with the greatest explanatory power for the beta anomaly. We also find that the impact of lottery effects on the cross-section of stock returns depends on beta, especially for stocks having small to medium levels of institutional ownership. In addition, by showing the robust long-run outperformance of low-beta stocks, especially those with low institutional ownership, our empirical analysis draws practical lessons for individual investors.