Are High Beta Stocks Like Call Options?
By Eric Falkenstein: Dave Cowan and Sam Wildeman at GMO have a new paper, Re-thinking Risk (check here or here if that doesn't work), that makes the argument that the poor performance of high beta stocks makes perfect sense. Their idea is that high beta stocks actually are leveraged with a put option, because unlike a levered fund where you can lose 2 times your investment (200%), a beta=2 portfolio can only lose 100%. In their words:
The point here is that the form of leverage offered by high beta is different in an important way from explicit borrowing. Investors should prefer this kind of leverage, and, in an efficiently priced market, they will accept a lower return for it. As we will show, the performance of high beta is not a product of excessive demand, but rather a reasonable and rational consequence of the fact that it provides a convex payoff toComplete Story »