Abstract
We show analytically and empirically that the positive abnormal returns from Betting-Against-Beta (BAB) – a beta-neutral portfolio long in low beta stocks and short in high beta stocks – are consistent with market segmentation due to costly information acquisition, as in Merton (1987). Consistent with our predictions, expected returns and CAPM alphas from the BAB strategy are positive and vary (1) negatively in the cross-section with firm visibility, and (2) positively in the time-series with the portfolio’s shadow cost of information and beta spread. These results cannot be fully explained by alternate explanations such as funding illiquidity or preference for lottery-like stocks.
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