Low Risk Anomalies?

Paul Schneider, Christian Wagner, Josef Zechner

Research output: Contribution to conferencePaperResearchpeer-review

Abstract

This paper shows theoretically and empirically that beta- and volatility-based low risk anomalies are driven by return skewness. The empirical patterns concisely match the predictions of our model that endogenizes the role of skewness for stock returns through default risk. With increasing downside risk, the standard capital asset pricing model (CAPM) increasingly overestimates expected equity returns relative to firms' true (skew-adjusted) market risk. Empirically, the profitability of betting against beta/volatility increases with firms' downside risk, and the risk-adjusted return differential of betting against beta/volatility among low skew firms compared to high skew firms is economically large. Our results suggest that the returns to betting against beta or volatility do not necessarily pose asset pricing puzzles but rather that such strategies collect premia that compensate for skew risk. Since skewness is directly connected to default risk, our results also provide insights for the distress puzzle.
This paper shows theoretically and empirically that beta- and volatility-based low risk anomalies are driven by return skewness. The empirical patterns concisely match the predictions of our model that endogenizes the role of skewness for stock returns through default risk. With increasing downside risk, the standard capital asset pricing model (CAPM) increasingly overestimates expected equity returns relative to firms' true (skew-adjusted) market risk. Empirically, the profitability of betting against beta/volatility increases with firms' downside risk, and the risk-adjusted return differential of betting against beta/volatility among low skew firms compared to high skew firms is economically large. Our results suggest that the returns to betting against beta or volatility do not necessarily pose asset pricing puzzles but rather that such strategies collect premia that compensate for skew risk. Since skewness is directly connected to default risk, our results also provide insights for the distress puzzle.

Conference

ConferenceThe 43rd European Finance Association Annual Meeting (EFA 2016)
Number43
LocationBI Norwegian Business School
CountryNorway
CityOslo
Period17/08/201620/08/2016
Internet address

Keywords

  • Low risk anomaly
  • Skewness
  • Credit risk
  • Risk premia
  • Equity options

Cite this

Schneider, P., Wagner, C., & Zechner, J. (2016). Low Risk Anomalies?. Paper presented at The 43rd European Finance Association Annual Meeting (EFA 2016), Oslo, Norway.
Schneider, Paul ; Wagner, Christian ; Zechner, Josef. / Low Risk Anomalies?. Paper presented at The 43rd European Finance Association Annual Meeting (EFA 2016), Oslo, Norway.55 p.
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Schneider, P, Wagner, C & Zechner, J 2016, 'Low Risk Anomalies?' Paper presented at, Oslo, Norway, 17/08/2016 - 20/08/2016, .

Low Risk Anomalies? / Schneider, Paul; Wagner, Christian; Zechner, Josef.

2016. Paper presented at The 43rd European Finance Association Annual Meeting (EFA 2016), Oslo, Norway.

Research output: Contribution to conferencePaperResearchpeer-review

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Schneider P, Wagner C, Zechner J. Low Risk Anomalies?. 2016. Paper presented at The 43rd European Finance Association Annual Meeting (EFA 2016), Oslo, Norway.