A risk-adjusted return measures an investment's return after taking into account the

degree of risk that was taken to achieve it.

However, when markets are providing returns, we also strive to maximize capital gains including
the selective use of leverage to enhance our return potential.  While leverage will always
increase volatility, applying leverage to low volatility funds can provide upside potential
without dramatically increasing overall portfolio volatility and risk. 
Low volatility stocks have the potential to generate higher risk-adjusted returns than their
high volatility.
Asset managers are motivated to invest in profit-maximizing, high beta stocks.4 , they may
be willing to overpay for stocks that outperform in up markets, which tend to be highly volatile in
nature, and underpay for those that outperform in down markets, which typically have low
volatility characteristics.
One academic study also highlights how leverage constraints contribute to the low volatility
effect.5 Based on their risk appetite, investors may be able to enhance their returns by
leveraging a low volatility portfolio. This may allow them to increase their return potential
without taking on additional risk. But due to leverage (or borrowing) constraints, they
tend to overweight riskier investments in search of higher returns, therefore lowering
their expected returns. risk quá dễ chết, lower expected return

Narrowing the focus to US equities, the research shows the least volatile decile made average returns
of 12 per cent over the same period and the most volatile lost 7 per cent.

Narrowing the focus to US equities, the research shows the least volatile decile made average returns
of 12 per cent over the same period and the most volatile lost 7 per cent.

At an ideal level of financial leverage, a company's return on equity increases because the use
of leverage increases stock volatility, increasing its level of risk which in turn increases
returns.

 low risk thì khả năng lợi và khả năng rủi sẽ gần như bằng nhau, dùng leverage làm tăng
volatility  tăng thêm return.
 Nếu đã high volatility rồi, còn leverage thì risk quá cao, dễ lower expected return

Vd: High risk, high volatility (40%)

Expected return = 30%.70+70%.30= 42$

ST=70$

S0=50$

ST=30
Vd: Low risk, low volatility: Expected return = 60x30% + 40x70%=46$

ST=60$
S0=50$

ST=40$

2. Theory
OLG economy (1)

Consider an overlapping-generations (OLG) economy: (OLG model) is a simplified theoretical

representation of complicated economic processes through a set of identities and equations that describe
the behavior of various agents interacting with each other.

 Agents:

 Mua share: Agents trade securities:

 Securities pays dividend:

 Có share: Share outstanding: (total number of shares held by a company's shareholders at

a particular time)

 Each time of period t, agents choose a portfolio of shares: , investing the rest

of their wealth to risk free rate return to maximize the utility

 : vector of prices at time t

 : variance– covariance matrix of

  : the agent’s risk aversion

Max portfolio’.(expected return (price at time (t+1) + dividend at time (t+1)) – (1+risk free rate).price at
time t))-risk aversion/2 . portfolio’. covariance matrix between price and dividend. Portfolio

Agent i is subject to the portfolio constraint (2)

 : total dollar invested

 : the sum of the number of shares

 : agents wealth

The investment constraint depends on the agent i.

 No leverage and have some wealth in cash, (Ex: , an agent who

must hold 20% of her wealth in cash, vd công ty bảo hiểm cần có sẵn cash để trả các tình huống
bất ngờ)

 Could use leverage, but margin constraint, (if an agent faces a margin requirement of
50%, then his )

Competitive equilibrium: the total demand equals the supply (3)

From (1) and (3) 

Lấy đạo hàm của (1) rồi áp (3) vào

The equilibrium price can then be computed:

Return of any security

Return on the market

Beta

Proposition 1: High Beta is low Alpha

A security's alpha with respect to the market

 Actual return – return in capm model

For an efficient portfolio, the Sharpe ratio:

 Highest for an efficient portfolio with a Beta<1

 Decrease when increase

 Increase when decrease

 Implication of proposition 1: Càng constraints (
higher), intercept càng cao, expected return càng cao,
slope càng giảm
Equilibrium required return for any security s

 Risk premium:

 Average Lagrange multiplier: , measuring the tightness of funding constraints

Trong Black CAPM, hạn chế borrow ( ). Required return= Constant+Beta x Risk premium.

Lower slope = lower compensation for a marginal increase in systematic risk.

The slope is lower because constrained agents need high unleveraged returns and are, therefore, willing
to accept less compensation for higher risk Slope is alpha (the excess return over the market
return. )

The security market line (SML) is a line drawn on a chart that serves as a graphical representation of
the capital asset pricing model (CAPM)—which shows different levels of systematic, or market risk, of
various marketable securities, plotted against the expected return of the entire market at any given time.

Also known as the "characteristic line," the SML is a visualization of the CAPM, where the x-axis of the
chart represents risk (in terms of beta), and the y-axis of the chart represents expected return.
The market risk premium of a given security is determined by where it is plotted on the chart relative to
the SML.

 The SML can help to determine whether an investment product would offer a favorable expected
return compared to its level of risk
Càng constraint, càng muốn high beta, riskier để tăng returnexpected return tăng, tăng intercept
 Slope là cái góc = Expected return – Rf, slope càng giảm
Portfolio constraint is measured by the average Lagrange multiplier ψt.

Standard CAPM implies:

Binding funding contraints:

 Increase the intercept of the security market line

Funding constraints is measured through the weighted average of the agents' Lagrange
multipliers)

_____________________________________________

Why zero-beta assets require returns in excess of the risk-free rate?

 First, constrained agents prefer to invest their limited capital in riskier assets with higher
expected return. Càng ít tiền thì càng thích đầu tư vào risk asset để high return
 Second, unconstrained agents do invest considerable amounts in zero-beta assets so, from their
perspective, the risk of these assets is not idiosyncratic, as additional exposure to such assets
would increase the risk of their portfolio. Hence, in equilibrium, zero-beta risky assets must
offer higher returns than the risk-free rate Vay mượn được thì thích đầu tư vào zero-beta
asset (ít volatility), nhưng càng nhiều asset với zero beta cũng dễ tăng risk  Zero beta risky
asset phải higher return than risk free rate thì mới higher risk được

Tuy nhiên, cũng có zero beta asset có risk free rate

Assets with zero covariance: “tangency portfolio”

 Held by an unconstrained agent

 Earn the risk-free rate
 However, Not the market portfolio in our equilibrium.

Nhưng asset này trong phải market portfolio mà ta đang xét

The market portfolio is the weighted average of all investors' portfolios, riskier portfolios
  Held by constrained investors.
 Has higher risk and expected return than the tangency portfolio,
 Lower Sharpe ratio. (risk càng cao thì beta cao, alpha thấp, sharpe ratio thấp)

Proposition 2.1: Betting against Beta

Betting-Against-Beta (BAB) factors: A BAB factor is a market-neutral with beta=0
(A market-neutral strategy is a type of investment strategy undertaken by an investor or an investment
manager that seeks to profit from both increasing and decreasing prices in one or more markets while
attempting to completely avoid some specific form of market risk.)

– Long low-beta assets, levered to a beta of 1

– Short high-beta assets, de-levered to a beta of 1

 Low-beta assets with return (wL be the relative portfolio weights for a
portfolio of low-beta assets)

 High-beta assets with return

 Beta of these portfolio:

Proposition 2.2: BAB portfolio s earns a positive

expected return on average.
The expected excess return of the self-financing BAB factor is positive

The size of the expected return depends on

 The spread in the betas (giữa beta cao và beta thấp)

 How binding the portfolio constraints are in the market/funding tightness ( ) (càng constraint
thì expected return càng cao)
Proposition 3: Constraints sẽ tăng expected return, tuy
nhiên shock to constraints, constraints quá mức quá sẽ
dẫn tới loss
When portfolio constraints become more binding (a higher for some k), agents may need to de-
leverage their bets against beta or stretch even further to buy the high-beta assets.  the BAB factor is
exposed to funding liquidity risk

 It results in loss

 It results in an increase in its future required return

Proposition 4: Funding shock in cross section:

Betas of securities in the cross section are compressed
toward 1 when funding liquidity risk is high
Funding shocks have further implications for the cross section of asset returns and the BAB portfolio

A funding shock makes all security prices drop together

The percentage price sensitivity with respect to funding shocks

 An increased funding risk compresses betas toward one.

 The conditional return betas of all securities are compressed toward 1 (more dispersed)
 The conditional beta of the BAB portfolio becomes positive (negative), even though it is market
neutral relative to the information set used for portfolio formation.  tức là nó không nhất
thiết beta=0, mà có thể >0 hoặc <0
 Proposition 5: Unconstrained agents hold risk free securities
and a portfolio of risky securities that has a beta less than 1;
Constrained agents hold portfolios of securities with higher betas

To state this result, we write next period's security payoffs as:

 b is a vector of market exposures

 e is a vector of noise that is uncorrelated with the market

If securities s and k are identical except that s has a larger market exposure than k, (nếu 2
securities như nhau, chỉ khác ở chỗ securities s sẽ violity hơn security k)

 Constrained agent j with greater than average Lagrange multiplier, holds more
shares of s than k  constraints agent sẽ chọn securities s

 The reverse is true for any agent with  unconstraints sẽ chọn securities k

3. Data and methodology

The data in this study are collected from several sources. The sample of US and international equities
has 55,600 stocks covering 20 countries, and the summary statistics for stocks are reported in Table 1.
Stock return data are from the union of the Center for Research in Security Prices (CRSP) tape and the
Xpressfeed Global database. Our US equity data include all available common stocks on CRSP between
January 1926 and March 2012, and betas are computed with respect to the CRSP value weighted market
index. Excess returns are above the US Treasury bill rate. We consider alphas with respect to the market
factor and factor returns based on size (SMB), book-to-market (HML), momentum (up minus down,
UMD), and (when available) liquidity risk.

The international equity data include all available common stocks on the Xpressfeed Global daily
security file for 19 markets belonging to the MSCI developed universe between January 1989 and
March 2012. We assign each stock to its corresponding market based on the location of the primary
exchange. Betas are computed with respect to the corresponding MSCI local market index.

All returns are in US dollars, and excess returns are above the US Treasury bill rate. We compute
alphas with respect to the international market and factor returns based on size (SMB), book-to-market
(HML), and momentum (UMD) from Asness and Frazzini (2013) and (when available) liquidity risk

We also consider a variety of other assets. Table 2 contains the list of instruments and the
corresponding ranges of available data. We obtain US Treasury bond data from the CRSP US Treasury
Database, using monthly returns (in excess of the one-month Treasury bill) on the Fama Bond portfolios
for maturities ranging from one to ten years between January 1952 and March 2012. Each portfolio
return is an equal-weighted average of the unadjusted holding period return for each bond in the
portfolio. Only non-callable, non-flower notes and bonds are included in the portfolios. Betas are
computed with respect to an equally weighted portfolio of all bonds in the database.

We collect aggregate corporate bond index returns from Barclays Capital's Bond.Hub database. Our
analysis focuses on the monthly returns (in excess of the onemonth Treasury bill) of four aggregate US
credit indices with maturity ranging from one to ten years and nine investment-grade and high-yield
corporate bond portfolios with credit risk ranging from AAA to Ca-D and Distressed. The data cover the
period between January 1973 and March 2012, although the data availability varies depending on the
individual bond series. Betas are computed with respect to an equally weighted portfolio of all bonds in
the database.

We also study futures and forwards on country equity indexes, country bond indexes, foreign
exchange, and commodities. Return data are drawn from the internal pricing data maintained by AQR
Capital Management LLC. The data are collected from a variety of sources and contain daily return on
futures, forwards, or swap contracts in excess of the relevant financing rate. The type of contract for
each asset depends on availability or the relative liquidity of different instruments. Prior to expiration,
positions are rolled over into the next most-liquid contract. The rolling date's convention differs across
contracts and depends on the relative liquidity of different maturities. The data cover the period
between January 1963 and March 2012, with varying data availability depending on the asset class. For
more details on the computation of returns and data sources, see Moskowitz, Ooi, and Pedersen (2012),
Appendix A. For equity indexes, country bonds, and currencies, the betas are computed with respect to
a gross domestic product (GDP)-weighted portfolio, and for commodities, the betas are computed with
respect to a diversified portfolio that gives equal risk weight across commodities.

Finally, we use the TED spread as a proxy for time periods when credit constraints are more likely to
be binding [as in Garleanu and Pedersen (2011) and others]. The TED spread is defined as the
difference between the three-month Eurodollar LIBOR and the three-month US Treasuries rate. Our
TED data run from December 1984 to March 2012.

3.1. Estimating ex ante betas

Our estimated beta for security i is given by:

 : estimated volatilities for the stock and th market

 : their correlation