Does It Pay to Bet Against Beta? On the Conditional Performance of the Beta Anomaly

Prior studies find that a strategy that buys high-beta stocks and sells low-beta stocks has a significantly negative unconditional capital asset pricing model (CAPM) alpha, such that it appears to pay to bet against beta. We show, however, that the conditional beta for the high-minus-low beta portfolio covaries negatively with the equity premium and positively with market volatility. As a result, the unconditional alpha is a downward-biased estimate of the true alpha. We model the conditional market risk for beta-sorted portfolios using instrumental variables methods and find that the conditional CAPM resolves the beta anomaly.