The role of beta strategies in other asset pricing anomalies

Abstract

This thesis is based on the findings of Liu (2018), and therefore considers long-short, zero cost portfolios based on documented asset pricing anomalies. These include momentum, composite equity issuance, return volatility, and idiosyncratic volatility. Consistent with the observations in Liu (2018), we find that the relevant long-short portfolios embed significantly negative realized betas and therefore load in the low-beta anomaly. Neutralization of this exposure decreases the economic magnitude and statistical significance of their abnormal returns. In order to demonstrate this, we follow the methodology of Liu (2018) and propose a modification to one of the beta mitigation techniques. Also, we contribute with other methods, documented in the existing literature, that are designed either to reduce the beta imbalance or to account for the portfolios’ exposure to the beta anomaly. Furthermore, we contribute by testing all methods of beta mitigation for alternative pre-formation beta estimation techniques, in order to investigate if these a↵ect the explanatory power of the beta anomaly. Consistent with the findings of Liu (2018), we find that the mitigation of the inherent beta imbalance in the long-short anomaly portfolios either decreases or removes these strategies’ abnormal returns. The magnitudes of these reductions vary by choice of beta neutralization method and pre-formation beta estimation technique.