Beyond Rational - A study on the drivers of the beta anomaly in Sweden

Abstract: Inspired by previous findings that low (high) beta stocks earn abnormally high (low) returns we set out to explore this relation, often called the beta anomaly. We prove that the beta anomaly is present in our sample of Swedish stocks. The alpha generated by a betting against beta portfolio that exploits the beta anomaly is 1.71% per month. Both rational reasons such as leverage constrained investors and behavioural reasons such as lottery-seeking investors have been presented as explanations for the beta anomaly. Since lottery demand is mainly attributed to individual investors, Sweden is an interesting subject of study due to its high proportion of individual investor market participation. We examine the merit of the two explanations and conclude that the strange relation between beta and return can be attributed to both idiosyncratic and systematic factors. Finally, we construct a novel strategy that overcomes some of the problems of implementing a betting against beta portfolio. Invested in only 20% of our stock universe, the portfolio yields a monthly alpha of 2.17% and a Sharpe ratio of 1.14.