Overconfidence, Sentiment and Beta Herding : A Behavioral Explanation of the Low-Beta Anomaly

We investigate asset returns using the concept of beta herding, which measures cross-sectional variations in betas induced by investors whose beliefs about the market are biased due to changes in confidence or sentiment. Overconfidence or optimistic sentiment causes beta herding (compression of individual assets' betas towards the market beta), while under-confidence or pessimistic sentiment leads to adverse beta herding (dispersion of betas away from the market beta). We find that beta herding is related to the low-beta anomaly, as high beta stocks underperform low beta stocks on a risk-adjusted basis exclusively following periods of adverse beta herding. As an explanation of the low-beta anomaly, we propose the persistence of bias in betas (i.e., a large difference in betas) that lasts for more than one year as market uncertainty continues