Economic Uncertainty and the Beta Anomaly

Using various measures of economic uncertainty, we find that the beta-alpha anomaly exists only during periods of low economic uncertainty. We argue that diminished risk appetite during high economic uncertainty eases leverage constraints of typical long-only investors, making overvaluation of high-beta stocks and undervaluation of low-beta stocks less likely. Differences in uncertainty-related beta trading activities between mutual fund investors/managers and hedge funds support this explanation. Variation of the beta anomaly within the low-uncertainty state further corroborates it: the anomaly is significant (insignificant) in stocks heavily held by actively managed mutual funds (hedge funds), and it is concentrated in the subperiods in which leverage constraints for long-only investors are likely to be more severe. This paper was accepted by Lin William Cong, finance. Funding: Z. Cao and W. Wu acknowledge financial support from the National Natural Science Foundation of China [Grants 72495153 and 72310107002]. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2024.04372 .