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Understanding Defensive Equity

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  • Robert Novy-Marx

Abstract

High volatility and high beta stocks tilt strongly to small, unprofitable, and growth firms. These tilts explain the poor absolute performance of the most aggressive stocks. In conjunction with the well documented inability of the Fama and French three-factor model to price small growth stocks, especially unprofitable small growth stocks, these tilts also drive the abnormal performance of defensive equity (i.e., low volatility and/or low beta strategies). While defensive strategy performance is explained by controlling for size, profitability, and relative valuations, the converse is false--the performance of value and profitability strategies cannot by explained using defensive equity performance.

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  • Robert Novy-Marx, 2014. "Understanding Defensive Equity," NBER Working Papers 20591, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:20591
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    Cited by:

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    2. Blitz, David & Vidojevic, Milan, 2017. "The profitability of low-volatility," Journal of Empirical Finance, Elsevier, vol. 43(C), pages 33-42.
    3. Cuthbertson, Keith & Nitzsche, Dirk & O'Sullivan, Niall, 2022. "Mutual fund performance persistence: Factor models and portfolio size," International Review of Financial Analysis, Elsevier, vol. 81(C).
    4. Rajnish Mehra & Sunil Wahal & Daruo Xie, 2021. "Is idiosyncratic risk conditionally priced?," Quantitative Economics, Econometric Society, vol. 12(2), pages 625-646, May.
    5. Wan-Ni Lai & Yi-Ting Chen & Edward W. Sun, 2021. "Comonotonicity and low volatility effect," Annals of Operations Research, Springer, vol. 299(1), pages 1057-1099, April.
    6. Calice, Giovanni & Lin, Ming-Tsung, 2021. "Exploring risk premium factors for country equity returns," Journal of Empirical Finance, Elsevier, vol. 63(C), pages 294-322.
    7. Giuseppe Galloppo, 2021. "Size," Springer Books, in: Asset Allocation Strategies for Mutual Funds, chapter 0, pages 151-190, Springer.
    8. Wan-Ni Lai & Claire Y. T. Chen & Edward W. Sun, 2022. "Risk factor extraction with quantile regression method," Annals of Operations Research, Springer, vol. 316(2), pages 1543-1572, September.
    9. Valadkhani, Abbas, 2023. "Asymmetric downside risk across different sectors of the US equity market," Global Finance Journal, Elsevier, vol. 57(C).
    10. Asness, Cliff & Frazzini, Andrea & Gormsen, Niels Joachim & Pedersen, Lasse Heje, 2020. "Betting against correlation: Testing theories of the low-risk effect," Journal of Financial Economics, Elsevier, vol. 135(3), pages 629-652.
    11. Jordan, Bradford D. & Riley, Timothy B., 2015. "Volatility and mutual fund manager skill," Journal of Financial Economics, Elsevier, vol. 118(2), pages 289-298.
    12. Kuiper, Ivo, 2017. "Essays on investing in stock and bond markets," Other publications TiSEM a22daf8a-de91-4f96-8068-5, Tilburg University, School of Economics and Management.
    13. David Blitz & Matthias X. Hanauer & Pim Vliet, 2021. "The Volatility Effect in China," Journal of Asset Management, Palgrave Macmillan, vol. 22(5), pages 338-349, September.
    14. S. Ciliberti & Y. Lemp'eri`ere & A. Beveratos & G. Simon & L. Laloux & M. Potters & J. P. Bouchaud, 2015. "Deconstructing the Low-Vol Anomaly," Papers 1510.01679, arXiv.org, revised Oct 2015.
    15. Marinac, Martina & Vukoja, Marija, 2022. "Strategic Approach To Investment Portfolios Through The Prism Of Precious Metals," UTMS Journal of Economics, University of Tourism and Management, Skopje, Macedonia, vol. 13(1), pages 98-128.

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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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