The Reactive Beta Model

TL;DR

This paper introduces a reactive beta model incorporating leverage effects, enabling hedge fund managers to achieve near-zero market beta and improve bias correction in beta estimation for market neutral strategies.

Contribution

The paper develops a new reactive beta model that accounts for leverage effects, enhancing beta estimation accuracy for market neutral strategies.

Findings

Reactive beta reduces bias in beta estimates.

Model effectively targets near-zero beta in practice.

Empirical tests confirm improved performance across strategies.

Abstract

We present a reactive beta model that includes the leverage effect to allow hedge fund managers to target a near-zero beta for market neutral strategies. For this purpose, we derive a metric of correlation with leverage effect to identify the relation between the market beta and volatility changes. An empirical test based on the most popular market neutral strategies is run from 2000 to 2015 with exhaustive data sets including 600 US stocks and 600 European stocks. Our findings confirm the ability of the reactive beta model to withdraw an important part of the bias from the beta estimation and from most popular market neutral strategies.