Criticism
The low-volatility anomaly is a contentious topic in finance and has been a topic of extensive research since its discovery. Baker et al. (2011) attempt to explain this anomaly, basing their argument on the arbitrage being limited by benchmarks. The article focuses on two aspects of financial behavioral models, the first being the irrationality of some players in the financial market. The second aspect is the existing limits on arbitrage, and whether they act as benchmarks and barriers to investment in some markets. The article builds on initial research and offers incredible insights on the phenomenon while bettering the comprehension of the low-volatility anomaly. The study chronologically analyzes evidence from past studies on the topic, enabling a grasp of the history of this phenomenon. A significant shortcoming in the study is its emphasis on behavioral aspects of the anomaly alone when one factor cannot be responsible for a mishap as big as the low-volatility anomaly.
Extension and Personal Thoughts
The article could be extended by considering the grave impact constraints have on investors, leading to the low-volatility anomaly. The study could differentiate the leverage limitations and shorting constraints that investors face and adequately define them for a holistic approach to this phenomenon. An additional factor for extension is agency issues, including the misaligned interests investors may harbor when managing their clients’ money. The role of mutual fund managers in managing the low-volatility anomaly in the case of agency issues could also be explored, and the results of the research article were more conclusive. Save for the few shortcomings already mentioned, I find the article intriguing and very informative. It offers a new way of thinking about the low-volatility anomaly while encouraging debate on the topic, an initiative that will foster understanding.
Reference
Baker, M., Bradley, B., & Wurgler, J. (2011). Benchmarks as limits to arbitrage: Understanding the low-volatility anomaly.Financial Analysts Journal, 67(1), 40–54.