Last Updated on 10 February, 2024 by Rejaul Karim
Navigating the complexities of equity premia can be a daunting task for investors. The forthcoming article in the Journal of Futures Markets, “Beta and Size Equity Premia following a High-VIX Threshold,” sheds light on this intricate subject.
Drawing from an in-depth analysis, the authors – a distinguished team of finance experts – reveal that high-beta and small-cap stocks only yield positive risk premia after expected stock-market volatility surpasses a high threshold, around the 80th percentile. Interestingly, this threshold risk-return relationship manifests itself over months t+1 to t+6, while the premia remain negligible when volatility falls below this benchmark.
In contrast, the study finds no similar threshold behavior for Fama-French HML, RMW, and CMA factors. Through this research, the authors contribute valuable knowledge to decode the dynamics behind the threshold risk-return findings, offering guidance for those striving to capitalize on factor risk premia.
Abstract Of Paper
We show that a positive risk premium from holding high-beta stocks (versus low-beta stocks) and small-cap stocks (versus large-cap stocks) is reliably earned only after the expected stock-market volatility breaches a high threshold at about the 80th percentile. When exceeding this threshold at month t-1, then sizable positive average returns from beta and size exposure are persistently evident over months t+1 to t+6; otherwise the premia are near zero. Conversely, we find no comparable threshold behavior for the Fama-French HML, RMW, and CMA factors. Our investigation suggests several economic channels as likely contributors behind these threshold risk-return findings.
Original paper – Download PDF
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Saint Louis University – Department of Finance
Robert A. Connolly
University of Florida
Chris T. Stivers
University of Louisville
In conclusion, the thought-provoking research presented in “Beta and Size Equity Premia following a High-VIX Threshold” offers a valuable framework for understanding the nonlinear risk-return relationship in the context of high-beta and small-cap stocks.
This investigation uncovers the significance of an 80th percentile threshold in expected stock-market volatility, demonstrating how breaching this threshold leads to persistently positive average returns in beta and size exposure over six months. In contrast, Fama-French HML, RMW, and CMA factors exhibit no analogous threshold behavior.
By identifying key economic channels that contribute to these intriguing findings, the authors provide a solid foundation for further exploration into the intricacies of factor risk premia. Armed with this knowledge, investors can make more informed decisions as they strive to navigate the nuances of stock-market volatility and capitalize on emerging opportunities.
Q1: What is the main finding of the research paper regarding high-beta and small-cap stocks?
The research paper reveals that positive risk premia from holding high-beta and small-cap stocks are reliably observed only after expected stock-market volatility surpasses a high threshold, approximately at the 80th percentile. This threshold risk-return relationship leads to sizable positive average returns over the subsequent six months (t+1 to t+6), while the premia remain negligible when volatility is below this benchmark.
Q2: Is the threshold risk-return behavior observed in other factor risk premia?
No, the study finds no similar threshold behavior for other factor risk premia, specifically the Fama-French HML, RMW, and CMA factors. The threshold relationship appears to be unique to high-beta and small-cap stocks.
Q3: How can investors use this research to inform their investment decisions?
Investors can use this research to better understand the nuanced dynamics of factor risk premia, specifically in the context of high-beta and small-cap stocks. The identification of an 80th percentile threshold in expected stock-market volatility provides a valuable signal for when these stocks are more likely to yield positive risk premia. By incorporating this knowledge, investors can enhance their decision-making process and potentially capitalize on the timing of factor exposures for improved portfolio performance.