Abstract
This paper shows that leading theories of the low-risk anomaly fail to provide a complete explanation for the anomaly’s conditional performance. Sharpe ratios and abnormal returns of betting-against-beta (BAB) and -idiosyncratic volatility (BAV) factors rise significantly following low volatility months, even when controlling for lottery preferences, and in the case of BAB, also controlling for mispricing and limits to arbitrage. Moreover, the leverage constraints theory counterfactually predicts that market and BAB Sharpe ratios increase with volatility. We also show that highly active institutions shift from high- to low-beta stocks as volatility increases, suggesting their demand contributes to the performance of BAB.
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