Betting Against (Bad) Beta

TL;DR

This paper introduces a Betting Against Bad Beta (BAB) factor that improves upon the original BAB strategy by accounting for bad-beta, demonstrating enhanced performance when transaction costs are managed effectively.

Contribution

It proposes a novel double-sorting method on beta and bad-beta to refine BAB strategies, addressing limitations of previous approaches.

Findings

BAB strategies are improved by considering bad-beta

Double-sorting enhances risk-adjusted returns

Proper transaction cost management is crucial for success

Abstract

Frazzini and Pedersen (2014) Betting Against Beta (BAB) factor is based on the idea that high beta assets trade at a premium and low beta assets trade at a discount due to investor funding constraints. However, as argued by Campbell and Vuolteenaho (2004), beta comes in "good" and "bad" varieties. While gaining exposure to low-beta, BAB factors fail to recognize that such a portfolio may tilt towards bad-beta. We propose a Betting Against Bad Beta factor, built by double-sorting on beta and bad-beta and find that it improves the overall performance of BAB strategies though its success relies on proper transaction cost mitigation.