Skip to content

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

A portfolio manager observes that, historically, US stocks in the lowest beta quintile have delivered higher risk-adjusted returns than stocks in the highest beta quintile. Which statement best describes this finding relative to the CAPM?

The low-risk anomaly contradicts the CAPM because the model predicts expected returns rise with beta, but empirically the relationship is flatter than the security market line implies. Low-beta stocks earn positive alpha and high-beta stocks earn negative alpha relative to CAPM predictions.

  1. AIt is consistent with the CAPM, which predicts that high-beta stocks have lower returns than low-beta stocks
  2. BIt contradicts the CAPM, because the security market line would predict a positive relationship between beta and expected return, yet the empirical line is flatter than predictedCorrect
  3. CIt confirms the CAPM, because low-beta stocks have lower total volatility and hence require a higher return
  4. DIt is irrelevant to the CAPM, because the CAPM only applies to portfolios of bonds

Explanation

The CAPM predicts expected return rises linearly with beta along the security market line. Empirically, the line is too flat: low-beta assets earn more than predicted and high-beta assets earn less, giving positive alpha for low beta. Option A misstates the CAPM's prediction.

Did you get it right without looking?

One question tells you little. A timed set on Alpha (and the Low-Risk Anomaly) shows your real accuracy, how long you take and where you lose marks.

Practise Alpha (and the Low-Risk Anomaly)Free diagnostic mock

More Alpha (and the Low-Risk Anomaly) questions