Re-Thinking Risk – What the Beta Puzzle Tells Us about Investing

One cornerstone of fi nance theory is that investors demand return in exchange for assuming risk. As a consequence,the long-term returns of an investment strategy should be commensurate with the risks the strategy takes. Thisproposition sounds reasonable and intuitive, but it remains controversial. As both academics and practitioners havenoted, there appear to be some anomalies, i.e., investment strategies that generate returns greater than expected inlight of their perceived risks. One example that has generated considerable discussion recently in both academic andpractitioner circles is what one might call the “beta puzzle”: portfolios of low beta stocks have historically matched orbeaten broader equity market returns, and have done so with signifi cantly lower volatility. At the same time, high beta

stocks have signifi cantly underperformed, exhibiting lower returns while appearing to take much more risk.1


From: “Deora, Biharilal” <biharilal.deora@credit-suisse.com>
Date: Fri, 18 Nov 2011 08:13:14 +0530
To: <deoralalbihari@gmail.com>
Subject: Re-Thinking Risk – What the Beta Puzzle Tells Us about Investing

One cornerstone of fi nance theory is that investors demand return in exchange for assuming risk. As a consequence,

the long-term returns of an investment strategy should be commensurate with the risks the strategy takes. This

proposition sounds reasonable and intuitive, but it remains controversial. As both academics and practitioners have

noted, there appear to be some anomalies, i.e., investment strategies that generate returns greater than expected in

light of their perceived risks. One example that has generated considerable discussion recently in both academic and

practitioner circles is what one might call the “beta puzzle”: portfolios of low beta stocks have historically matched or

beaten broader equity market returns, and have done so with signifi cantly lower volatility. At the same time, high beta

stocks have signifi cantly underperformed, exhibiting lower returns while appearing to take much more risk.1

<<ReThinkingRisk_BetaPuzzle_1111.pdf>>

ReThinkingRisk_BetaPuzzle_1111.pdf

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