Betting against beta

TLDR

The paper proposes a model in which leverage and margin constraints differ across investors and over time. The model incorporates these varying constraints to explain asset‑pricing dynamics. Empirical tests confirm five predictions: high‑beta assets are bid up by constrained investors, producing low alpha; a betting‑against‑beta factor yields significant positive risk‑adjusted returns; the factor’s return falls when funding constraints tighten; liquidity risk compresses betas toward one; and more constrained investors hold riskier assets.

Abstract

We present a model with leverage and margin constraints that vary across investors and time. We find evidence consistent with each of the model's five central predictions: (1) Because constrained investors bid up high-beta assets, high beta is associated with low alpha, as we find empirically for US equities, 20 international equity markets, Treasury bonds, corporate bonds, and futures. (2) A betting against beta (BAB) factor, which is long leveraged low-beta assets and short high-beta assets, produces significant positive risk-adjusted returns. (3) When funding constraints tighten, the return of the BAB factor is low. (4) Increased funding liquidity risk compresses betas toward one. (5) More constrained investors hold riskier assets.