Working Paper: NBER ID: w16601
Authors: Andrea Frazzini; Lasse H. Pedersen
Abstract: We present a model in which some investors are prohibited from using leverage and other investors' leverage is limited by margin requirements. The former investors bid up high-beta assets while the latter agents trade to profit from this, but must de-lever when they hit their margin constraints. We test the model's predictions within U.S. equities, across 20 global equity markets, for Treasury bonds, corporate bonds, and futures. Consistent with the model, we find in each asset class that a betting-against-beta (BAB) factor which is long a leveraged portfolio of low-beta assets and short a portfolio of high-beta assets produces significant risk-adjusted returns. When funding constraints tighten, betas are compressed towards one, and the return of the BAB factor is low.
Keywords: No keywords provided
JEL Codes: E43; G1; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| investors prohibited from using leverage (G24) | overweight high-beta assets (C46) |
| overweight high-beta assets (C46) | lower risk-adjusted returns for those assets (G11) |
| investors facing margin constraints (G19) | underweight high-beta assets (G12) |
| investors facing margin constraints (G19) | overweight low-beta assets (G19) |
| tighter funding constraints (H60) | flatter security market line (G10) |
| flatter security market line (G10) | lower expected returns on high-beta assets (G12) |
| flatter security market line (G10) | higher expected returns on low-beta assets (G12) |
| betting against beta (BAB) strategy (C46) | significant risk-adjusted returns (G11) |
| betas of securities compress towards 1 (G12) | lower dispersion of betas during high funding liquidity risk (C46) |
| tightening funding liquidity constraints (E51) | negative returns for BAB factor (G12) |