FRM Part II · FRM Exam Part II · Factors
An analyst notes that a long-only low-volatility equity portfolio has a market beta of 0.70 and a historical alpha relative to the CAPM that is positive. Which statement best describes why this is called an anomaly?
The low-risk anomaly is that CAPM implies higher beta should earn higher expected return, yet low-beta and low-volatility stocks have historically delivered equal or better risk-adjusted returns than high-risk stocks, producing positive alpha for low-risk portfolios.
- ACAPM predicts higher expected return for higher beta, yet low-risk stocks have historically delivered risk-adjusted returns at least as high as high-risk stocksCorrect
- BCAPM predicts that low-beta stocks must earn negative excess returns, which has been observed
- CLow-volatility stocks have historically had higher betas than the market
- DThe anomaly arises because low-volatility stocks are always small-cap stocks
Explanation
Under CAPM, expected return rises linearly with beta. Empirically, low-beta and low-volatility stocks have shown flatter-than-predicted or even comparable returns, producing positive alpha. This contradicts the risk-return trade-off, hence the anomaly.
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