TY - JOUR
T1 - Betting Against Correlation
T2 - Testing Theories of the Low-risk Effect
AU - Asness, Clifford S.
AU - Frazzini, Andrea
AU - Gormsen, Niels Joachim
AU - Pedersen, Lasse Heje
N1 - Available online, July 12 2019
PY - 2020/3
Y1 - 2020/3
N2 - We test whether the low-risk effect is driven by leverage constraints and, thus, risk should be measured using beta versus behavioral effects and, thus, risk should be measured by idiosyncratic risk. Beta depends on volatility and correlation, with only volatility related to idiosyncratic risk. We introduce a new betting against correlation (BAC) factor that is particularly suited to differentiate between leverage constraints and behavioral 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.
AB - We test whether the low-risk effect is driven by leverage constraints and, thus, risk should be measured using beta versus behavioral effects and, thus, risk should be measured by idiosyncratic risk. Beta depends on volatility and correlation, with only volatility related to idiosyncratic risk. We introduce a new betting against correlation (BAC) factor that is particularly suited to differentiate between leverage constraints and behavioral 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.
KW - Asset pricing
KW - Leverage constraints
KW - Lottery demand
KW - Margin
KW - Sentiment
KW - Asset pricing
KW - Leverage constraints
KW - Lottery demand
KW - Margin
KW - Sentiment
U2 - 10.1016/j.jfineco.2019.07.003
DO - 10.1016/j.jfineco.2019.07.003
M3 - Journal article
SN - 0304-405X
VL - 135
SP - 629
EP - 652
JO - Journal of Financial Economics
JF - Journal of Financial Economics
IS - 3
ER -