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Journal of Financial Economics Vol. 135 No. 3 2020

Betting against correlation: Testing theories of the low-risk effect

Cliff Asness1; Andrea Frazzini1; Niels Joachim Gormsen2; Lasse Heje Pedersen3,4

1 AQR Capital Management, LLC, Two Greenwich Plaza, Greenwich, CT 06830, USA · 2 University of Chicago · 3 Copenhagen Business School · 4 Centre for Economic Policy Research

open access

Abstract

We test whether the low-risk effect is driven by leverage constraints and, thus, risk should be measured using beta versus behavioral effects and, thus, risk should be measured by idiosyncratic risk. Beta depends on volatility and correlation, with only volatility related to idiosyncratic risk. We introduce a new betting against correlation (BAC) factor that is particularly suited to differentiate between leverage constraints and behavioral explanations. BAC produces strong performance in the US and internationally, supporting leverage constraint theories. Similarly, we construct the new factor SMAX to isolate lottery demand, which also produces positive returns. Consistent with both leverage and lottery theories contributing to the low-risk effect, we find that BAC is related to margin debt while idiosyncratic risk factors are related to sentiment.

DOI
10.1016/j.jfineco.2019.07.003
Volume
135
Issue
3
Pages
629-652
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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