FRM Part II · FRM Exam Part II · Factors
An analyst runs a regression of a portfolio's excess returns on the market factor and finds a beta of 0.70 and a positive alpha. The portfolio holds stocks with low past volatility. Under the low-volatility anomaly, which is the most consistent interpretation of the positive alpha relative to the CAPM?
The positive alpha is consistent with the low-risk anomaly: low-beta, low-volatility stocks have historically delivered higher risk-adjusted returns than the CAPM security market line predicts. The risk-return relationship is flatter than theory implies, so low-beta holdings show positive alpha and high-beta holdings tend to show negative alpha.
- ALow-beta stocks have historically earned higher risk-adjusted returns than the CAPM's security market line predictsCorrect
- BLow-beta stocks earn returns exactly proportional to beta, so the alpha is estimation noise by definition
- CHigh-beta stocks have historically earned more than the CAPM predicts
- DThe alpha arises because low-volatility stocks have higher market beta than assumed
Explanation
The low-risk anomaly states that low-beta or low-volatility stocks have earned returns above those implied by the CAPM, giving positive alpha, while high-beta stocks tend to earn less than predicted. The flat or inverted risk-return relationship is the core of the anomaly.
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