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The Booms and Busts of Beta Arbitrage

Author

Listed:
  • Shiyang Huang

    (Faculty of Business and Economics, The University of Hong Kong, Pokfulam Road, Hong Kong)

  • Xin Liu

    (School of Finance, Renmin University of China, Beijing 100872, China)

  • Dong Lou

    (London School of Economics, London WC2A 2AE, United Kingdom; Center for Economic and Policy Research, Washington, DC 20009)

  • Christopher Polk

    (London School of Economics, London WC2A 2AE, United Kingdom; Center for Economic and Policy Research, Washington, DC 20009)

Abstract

Low-beta stocks deliver high average returns and low risk relative to high-beta stocks, an opportunity for professional investors to “arbitrage” away. We argue that beta-arbitrage activity generates booms and busts in the strategy’s abnormal trading profits. In times of low arbitrage activity, the beta-arbitrage strategy exhibits delayed correction, taking up to three years for abnormal returns to be realized. In contrast, when arbitrage activity is high, prices overshoot and then revert in the long run. We document a novel positive-feedback channel operating through firm leverage that facilitates these boom-and-bust cycles.

Suggested Citation

  • Shiyang Huang & Xin Liu & Dong Lou & Christopher Polk, 2024. "The Booms and Busts of Beta Arbitrage," Management Science, INFORMS, vol. 70(8), pages 5367-5385, August.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:8:p:5367-5385
    DOI: 10.1287/mnsc.2023.4929
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    4. Antoniou, Constantinos & Mitali, Shema F., 2023. "Do stock-level experienced returns influence security selection?," Journal of Banking & Finance, Elsevier, vol. 157(C).

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    More about this item

    Keywords

    beta arbitrage; arbitrage capital; crowded trading; return comovement;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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