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FRM Part II · FRM Exam Part II · Alpha (and the Low-Risk Anomaly)

A betting-against-beta (BAB) portfolio goes long low-beta stocks and short high-beta stocks. The long leg has beta 0.60 and the short leg has beta 1.50. To make the portfolio market-neutral, how much should be held long per 1 unit of capital short, in terms of the long-leg notional?

The long leg should be 2.50 per 1 unit short. Market neutrality requires long notional times 0.60 to equal short notional times 1.50, so the long position is 1.50 divided by 0.60, which equals 2.50, meaning the long leg is levered.

  1. A0.40
  2. B2.50Correct
  3. C0.90
  4. D1.50

Explanation

Beta-neutral requires L x 0.60 = S x 1.50 with S=1. L = 1.50/0.60 = 2.50. Option 0.40 inverts the ratio; 1.50 ignores the long beta.

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