The Beta Anomaly

Abstract

The notion that high-beta stocks should earn higher average returns than low-beta is the cornerstone of modern finance. Empirical evidence not only does not support this prediction, high-beta stocks underperform low-beta stocks on a risk-adjusted basis. The beta anomaly is large, persistent, and exists in a variety of asset classes. This chapter argues and provides empirical evidence that lottery stock preferences combined with institutional constraints that limit arbitrage are important drivers of the beta anomaly. While gamblingprone investors pay the price for high-beta stocks in terms of poor returns, over the long run, investors of low-beta stocks benefit not only from the superior returns of these stocks but also from the boost in geometric mean returns that comes with low-risk investing.