Does Pakistan Stock Exchange Pay to Bet Against the Beta?

Abstract

Beta anomaly is regarded as one of the most puzzling phenomena in the history of finance as it negates the fundamental notion that a higher return can only be earned after taking more risk. This study conducts inquiries into the presence of the low beta anomaly in Pakistan Stock Exchange (PSX) after controlling for size and value, through the construction of an arbitrage portfolio by taking a long and short position on beta-sorted stocks. For this purpose, the study uses monthly data of all those stocks listed on PSX having data range from June 2001 to June 2017. The Fama-Macbeth methodology is used to derive the risk and returns relation by estimating beta on a 36-months rolling window. Initial testing of CAPM indicates a positive and significant relation between systematic risk and return. Further results reveal the presence of the low beta anomaly, as the lowest beta-sorted portfolio earns high average returns than the highest beta-sorted portfolio. The difference between this low-high beta-sorted average return is 6.4% in annualized terms. The performance of beta sorted portfolios is also compared on the Sharpe ratio. Results reveal that a low beta-sorted portfolio reports a higher Sharpe ratio as compared with a high beta-sorted portfolio. The arbitrage portfolio (short on highly beta portfolio and long on small beta portfolio) reports a significant difference in returns as compared with other portfolios. Arbitrage portfolio is also sub-divided based on the holding period yield and reveals that it out-performed other portfolios during the reported period of 2003 to 2009, however, in other time periods the results are not significantly different. Based on these results, investors may devise their portfolio strategies by considering this anomaly until risk-return relation reverts to equilibrium.