Betting Against Beta or Demand for Lottery
- Bali, Brown, Murray, and Tang
- A version of the paper can be found here.
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Frazzini and Pedersen (2014) document that a betting against beta strategy that takes long (short) positions in low (high) beta stocks generates large abnormal returns of 6.6% per year, and attribute this phenomenon to funding liquidity risk. We investigate alternative explanations for this effect, and find that it is caused by demand for lottery-like assets, a behavioral phenomenon. Requiring betting against beta portfolios to be neutral to lottery demand eliminates the abnormal returns. Controlling for lottery-demand, multivariate analyses detect a theoretically consistent positive relation between beta and returns. Factor models that include our lottery-demand factor explain the abnormal returns of betting against beta portfolios. We conclude that the betting against beta phenomenon is driven by demand for lottery-like stocks.
This paper documents that the betting against beta (BAB) strategy is mainly driven by investors demand for lottery-like stocks. The authors use the MAX measure, defined as the average of the highest five daily stock returns over the past month, to proxy for the lottery-demand of a stock. Figure 1 shows a heat map of the stocks that fall into portfolios measured by Beta and the MAX (lottery demand) measures:
The above picture documents that high beta stocks also have a high lottery demand, while low beta stocks also have a low lottery demand. The authors then construct a measure, labeled FMAX, as a lottery-demand factor. The results are informative:
Once the authors control for the lottery-demand (FMAX factor), the alpha for the BAB strategy becomes insignificant!