Beta excess return

[quibowibbler]

I've been reading an academic paper where a system was set up to advise on going long or short on a stock based on some indicator values.

I thought it was odd that the author wanted to go short if the beta excess return (BXRET) of a stock was negative.

I thought that beta excess return was negative if the stock went up less than expected. Considering a case where a stock goes up by 5% but it was expected by the CAPM model to go up by 10%, BXRET = -5 but the value of the stock still went up, so you'd have wanted to go long on it.

Should I highlight this to the author, or is my understanding incorrect?

Thanks for any help
Adam

 

[anley]

I think you're missing the point because it's a hedged portfolio therefore if the market goes up the portfolio makes more on its long than it loses on its shorts. But if it goes down it makes more on its shorts that it loses on its longs. Hence the overall market direction has been taken out of the equation.

But if he didn't have the shorts on, the portfolio would be long only and would make a larger amount if the market went up but lose if it went down.

Losses are therefore good for a hedged portfolio as long as the overall portfolio increases in value. But take the short trades out and the portfolio becomes black or white, ie up or down depending on the overall market direction and so it's just another long only fund that can only make money in a bull market.

 

[quibowibbler]

Thanks,

I did start to think that perhaps he was trying to make the portfolio market neutral.

So if I was planing to use a smaller number of stocks in my portfolio, I guess I'd work out the beta over the portfolio rather than the market?