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Betting against beta with conditional modeling in Belgium stock market

Background and objectives: CAPM implies that there should exists positive relation between the returns’ and betas’ of the stocks and this relation should be equal to size of market risk premium. However empirical research has found that this relationship is too flat or even completely flat. Low beta stocks perform better and high beta stocks perform worse, than expected according their beta. To measure performance difference there has been created betting against beta (BAB) factor, which goes long to low beta stocks and shorts high beta stocks and positions are levered to have neutral market position. It has been shown that this factor generates positive four factor risk adjusted returns in USA market and in numerous international markets. BAB factors risk adjusted returns have been one the highest in Belgium stock market.

This study checks can unconditional or conditional asset pricing models with time varying betas explain returns related to BAB factor in Belgium stock market. It is also investigated how the factor exposures of BAB factor vary over time and different market conditions. Further it is checked can investor achieve statistically significant alpha in five year time interval by tilting his portfolio towards BAB factor in Belgium stock market.

Data and methodology: It is used daily and monthly factor return data from Belgium stock market from July 1990 to December 2015. Data is achieved from AQR Capital Management’s database. BAB returns are investigated through basic static factor regression models. To capture time variance on the factor exposure there is generated conditional factor models for BAB returns using smoothed Kalman filter. Also BAB returns varying exposures and alphas are checked through rolling regression with 5 year time window.

Results: Unconditional or conditional regression models can’t explain returns of BAB factor in Belgium stock market. In all broad sample regressions there exists statistically significant alpha. Adding momentum to three factor model cuts down alpha, but still statistically significant part of the returns are unexplained by the four factor model. In bear market times alpha related to BAB factor decreases substantially. BAB factor has negative market exposure most of the time. Overall BAB has positive exposure to momentum factor, which goes extremely strong in bear market times, but in bull markets this exposure vanishes. Overall BAB factor’s factor exposures get stronger in bear market times, except with size factor. Rolling regressions show that investor can rarely achieve statistically significant risk adjusted returns with 5 year investment horizon by tilting his portfolio towards BAB factor. Tilting portfolio towards BAB factor neither penalizes the investor in the unique way in the bad times.
Date14 January 2017
CreatorsViirret, J. (Jari)
PublisherUniversity of Oulu
Source SetsUniversity of Oulu
Detected LanguageEnglish
Typeinfo:eu-repo/semantics/masterThesis, info:eu-repo/semantics/publishedVersion
Rightsinfo:eu-repo/semantics/openAccess, © Jari Viirret, 2017

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