Abstract
Frazzini and Pedersen (2014) document that a betting against beta strategy that takes long positions in low-beta stocks and short positions in high-beta stocks generates a large abnormal return of 6.6% per year and they attribute this phenomenon to funding liquidity risk. We nd strong conrmation of their results on U.S. equity data, but provide evidence of an alternative explanation. Portfolio and regression analyses show that the betting against beta phenomenon disappears after controlling for the lottery characteristics of the stocks in our sample, while other measures of rm characteristics and risk fail to explain the eect. Furthermore, the betting against beta phenomenon only exists when the price impact of lottery demand falls disproportionately on high-beta stocks. We also nd that this lottery characteristic aggregates at the portfolio level and therefore cannot be diversied away. Finally, factor models that include our lottery demand factor explain the abnormal returns of the betting against beta portfolio as well as the betting against beta factor generated by Frazzini and Pedersen.
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