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Learning outcomes, after watching this video,

Â you will be able to implement the betting against beta strategy.

Â [MUSIC]

Â Let's continue with the betting against beta strategy.

Â So the paper is very complicated.

Â That's why I keep telling students that

Â these papers have a lot of entry barriers, so it's difficult to read the paper.

Â It's quite complicated and

Â technical, but the strategy that comes from the paper is very simple.

Â So if you follow the process that we explained at the beginning of this course,

Â then it's going to be fairly easy.

Â So I have taken you through the abstract, and simple strategy,

Â the idea is very simple.

Â There are stocks with high beta and low beta and

Â a lot of times these high beta stocks are more valued.

Â Constrained investors beat their prices up, and there is your opportunity.

Â So our trading strategy where you're short on high beta stocks and

Â long on low beta stocks is likely to make money.

Â Now this is strategy in a nutshell.

Â Now we already seen how, we've discussed about this, it comes from CAPM.

Â CAPM is a surprising model.

Â Basically all that you ought to do is expect the return from a stock

Â is risk free rate + Beta (MR- RFR).

Â And Alpha is, your Alpha is, let say, Actual return- Expected return.

Â 2:09

The good news is you need not calculate yourself.

Â So if you go to any financial website of your country, you'll get Betas for

Â most of the popular companies to companies which are traded well.

Â So this is not a difficult thing to obtain.

Â Once you obtain the Beta,

Â all that you ought to do is you ought to sort companies based on Beta.

Â So you can do it by industry, you can do it by market.

Â And if you have to, by asset class.

Â Suppose you are trading in different counties you can do it by country as well.

Â So once you rank stocks based on Beta, then you're to calculate median beta and

Â divide stocks into above median and below median.

Â You know that's it, it's such a simple strategy.

Â You do above median and below median.

Â And you can pause for a while and think, what issued long and what issued short?

Â So we said stocks which are in terms of Beta, they're all value.

Â And stocks which are below median in terms of Beta, they are under value.

Â So naturally the strategy is go long on those low Beta stocks and go short on high

Â Beta stocks, and hold it for a particular period and then close the position.

Â That's the strategy, strategy's very, very simple.

Â So we did all these backgrounds so that you're able to read the paper and then,

Â as I've said before, you're able to improvise.

Â Because when these kinds of papers come a lot of other researchers

Â work on these topics and they up the strategies further.

Â So you should be able to understand that as well and that is why we spend a lot of

Â time- explaining the background of this strategy.

Â Otherwise the strategy is simple and straightforward.

Â Another important question is about implementation.

Â If you go back to Petrosky, I said that you have to wait for

Â some time before, after the end of the year, after the end of any period.

Â If you recollect, what is the reason?

Â Because you'll have to wait for the accounting numbers to come.

Â If your year ends on December 31st, htere is no way on January 1st you will

Â know what the profits are, what the sales numbers are, you will not know that.

Â So you have I know the auditor said that their contents have to

Â prepare the numbers they have to get audited.

Â 4:30

The board has to audit, committee has to clear and there are a lot of procedures.

Â However here that's not the case.

Â All that you need to calculate Beta is return on market and

Â return on stock price.

Â Return on the stock, that's all you need.

Â So, the expected return of a stock is calculated this way.

Â So that is why this is quite easy to calculate return here.

Â Suppose you trade, your trading period starts on say January, June 1st let's say.

Â So what you ought to do is you ought to decide whether you will calculate Beta

Â over six months, one years, two years, whatever works best in your setting.

Â So once you select that period of two years,

Â say June 2017 is when you want to trade.

Â 5:40

And that is the number for each company.

Â And that you can calculate right as on June 30 after market does.

Â You don't need to wait for some company research, because these are stock prices.

Â So this trading strategy can be executed right on the first day of the year,

Â month, whatever, based on your holding.

Â How long you are to hold?

Â Ideally you should hold for a month, but you can try various combinations.

Â So what we have tried and we have tested using data is six month rolling window.

Â Again, what is this rolling window business?

Â So for every strategy, the way it works is, suppose for

Â a month you create a high Beta, low Beta portfolio,

Â it's quite possible that some high Beta stuff becomes low Beta next month.

Â 6:41

July 1st you start your trading.

Â Now what is the estimation window for July 1st?

Â That starts from January, ends on June.

Â So this is the estimation window for July 1st and

Â this is the trading, July 1st to August 1st, let's say.

Â 6:58

So this is the trading, so this is estimation and this is trading.

Â Now, what do you do?

Â January to June 30th, you calculate the Betas for all stocks, rank them, arrive

Â at your longs, arrive at your shorts, and do this, hold this for one month.

Â That is the first step.

Â Now once this, on July 31st, this should be July 31st.

Â [SOUND] Let's make it 31st of July.

Â Now once this is done, the next month, what you should do is take this month out.

Â Make it February to July.

Â Why? This is called a rolling window.

Â So make February to July and now calculate Beta all over again.

Â 7:51

So it's quite possible that your answer will change.

Â Many of the companies which are upper median in terms of Beta may

Â fall below median.

Â Quiet possible.

Â Of course those at the very top may not change, but those who are just about

Â median it's quiet possible they slip into the other category.

Â In those case you may have to change from long to short or

Â short to long based on a stock has moved from above to below or below to above.

Â It's quite possible, right?

Â So here then, your trading will start on August 1st and

Â end on August 31st, right?

Â Again, so on and so forth right.

Â Next one you would start in March, and your holding period will end on August.

Â And the billing will be from September 1st to September 30th.

Â 8:46

All that you are to do is for any month, go back six months,

Â beginning of the month, calculate pictures for all stocks, rank them,

Â and then divide them into above median and below median.

Â Go long on below median, short the more median, and hold for one month.

Â That's all about this strategy.

Â Now, again, are there risks here?

Â Yes, of course.

Â Like in any strategy, this is also risky.

Â It is not a guaranteed money-making scheme.

Â So that is why it's very important that you keep monitoring your portfolio.

Â The problem, the major reason, although, theoretically, this idea is very sound.

Â That constrained investors bid up the price of high Beta stocks.

Â And that is where they were all valued.

Â The determination of high Beta,

Â the concept of Beta, itself, is based on past prices.

Â That's a big problem.

Â 9:41

It's not necessary that the stocks which are high Beta here, so

Â the Beta that we actually need is the Beta applicable to this period.

Â But what we're using is the Beta that has happened in this period.

Â So that is why there are times when information sets change,

Â some high Beta stocks may become low Beta, or there is risk.

Â It is not a strategy where there is no risk.

Â But the research shows, 's paper shows that they've seen it in 20 countries.

Â They've seen it in different asset classes.

Â They've seen it in developed countries, they've tested this and it seems to work.

Â And we have also done some of our own homework and

Â our results indicates that this strategy works reasonably well.

Â So try this strategy.

Â Create a mock portfolio and

Â using a mock portfolio see how this works and then you can carry on.

Â