Betting Against Correlation: Testing Theories of the Low-risk Effect

Clifford S. Asness, Andrea Frazzini, Niels Joachim Gormsen, Lasse Heje Pedersen

Publikation: Working paperForskning


We test whether the low-risk effect is driven by (a) leverage constraints and thus risk should be measured using beta vs. (b) behavioral effects and thus risk should be measured by idiosyncratic risk. Beta depends on volatility and correlation, where only volatility is related to idiosyncratic risk. Hence, the new factor betting against correlation (BAC) is particularly suited to differentiating between leverage constraints vs. lottery explanations. BAC produces strong performance in the US and internationally, supporting leverage constraint theories. Similarly, we construct the new factor SMAX to isolate lottery demand, which also produces positive returns. Consistent with both leverage and lottery theories contributing to the low-risk effect, we find that BAC is related to margin debt while idiosyncratic risk factors are related to sentiment and casino profits.
UdgiverCentre for Economic Policy Research
Antal sider65
StatusUdgivet - 2018
NavnCentre for Economic Policy Research. Discussion Papers


  • Asset pricing
  • Leverage constraints
  • Lottery demand
  • Margins
  • Sentiment