Risk Anomaly: A Review of Literature

Abstract

Number of studies show that portfolio of low risk stocks outperform portfolio of high risk stocks as well as the market portfolio over the full market cycle on risk adjusted basis and in some cases, absolute basis as well in some cases. This surprising contradiction to classic finance theory led by CAPM has held its ground over long periods of time, across different markets and different methodological choices. This review paper aims at contributing to the body of knowledge in four ways. One, it highlights and links different strands of literature on low risk anomaly that has evolved over a period of time. Second, it highlights, different methodological choices that have been used. Third, it classifies explanations for persistence of risk anomaly in to economic and behavioral explanations and explanations that try to explain the anomaly away. Fourth, it reviews the state of current research and explores potential but yet underexplored areas of research on risk anomaly.