Betting Against Beta: Evidence from China

Abstract

Frazzini and Pedersen (2014) propose that investors with borrowing constraints will tilt toward risky stocks in portfolio construction, driving lower alpha for high-beta stocks. They further find that the betting against beta (BAB) portfolio of buying stocks with low beta and selling stocks with high beta produces a significantly positive annualized risk-adjusted return of 8.76% in U.S. market. This study investigates the BAB investment strategy in the Chinese market. Consistent with Frazzini and Pedersen (2014), I have the following five major findings. (1) The phenomenon of high-beta stock associated with low-alpha exists in China. (2) The BAB portfolio produces a significant annualized return up to 5.28% in China. The bans on margin trading and short selling were lifted on March 31, 2010. By utilizing this special institutional setting, I find that (3) the removal of stock-specific margin constraints mitigates the low-alpha phenomenon for high-beta securities. (4) The time-varying funding constraints negatively influence BAB returns. (5) The dispersion of beta tends to drop and the conditional market beta exhibits a U-shaped pattern when the funding liquidity risk increases.