Jan 17, 2012
Baker, Bradley and Wurgler (FAJ 2011) find that low-volatility stocks in the US outperform high-volatility stocks and attribute this apparent anomaly to investor behavioral biases as well as limits to arbitrage. What do you make of their argument?

EFF/KRF: It is just that, an argument. We have known since the '70s that the relation between beta and average return is much flatter than predicted by the CAPM. Their measure of total volatility is highly correlated with beta. They give a behavioral story, but other stories are consistent with their results. In any case, the CAPM has other more serious problems, and we think a multifactor model is necessary to capture, for example, the value premium in average returns, which shows little relation to beta.

Eugene F. Fama
The Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business
Kenneth R. French
The Roth Family Distinguished Professor of Finance at the Tuck School of Business at Dartmouth College
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Eugene Fama and Ken French are members of the Board of Directors for and provide consulting services to Dimensional Fund Advisors LP.