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The booms and busts of beta arbitrage

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  • Huang, Shiyang
  • Liu, Xin
  • Lou, Dong
  • Polk, Christopher

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

  • Huang, Shiyang & Liu, Xin & Lou, Dong & Polk, Christopher, 2023. "The booms and busts of beta arbitrage," LSE Research Online Documents on Economics 120807, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:120807
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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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    Keywords

    Paul Woolley Centre; Key Program of National Natural Science Foundation of China (NSFC Grant Number 72233003).;

    JEL classification:

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

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