Risk Anomaly in Indian Equity Market

Introduction
One of the basic principles we study in capital market is with high risk come high return and other end of risk is reward. So there is a direct relationship between risk and expected return. In an efficient market investors expect to realise above average returns only by taking above average risk. In capital market where the risk on investment is comparatively higher than other investment opportunity so as a premium for such risk bearing the investors are given a high return for such investment. This creates the basis for the principle theory risk-return trade off. There is an interesting discrepancy that exists in the academic literature between the theoretical predictions from standard asset pricing models regarding the risk-return relationship and the results obtained by researchers who have analysed this relationship in equity markets from a purely empirical perspective. Under certain condition a portfolio with low volatility stock can yield higher return than a high volatility portfolio. This phenomenon is called risk based anomaly

Objectives of the study

1. To understand the concept of low volatility anomaly 2. Exploring the risk anomaly in Indian Equity market

Methodology

The objective of the paper is to study the risk anomaly in Indian capital market to analyse the relationship between the risk and return. The study has been conducted by using secondary data from various sources. Descriptive and various empirical studies are used to analyse the impact. References of some articles have been also used to
find out the need, scope, opportunities and challenges in this direction in India.

Risk anomaly in Indian equity market Risk based anomaly is a new phenomenon in Indian capital market context. Low volatility anomaly is that portfolios of low volatile stock which yields maximum risk adjusted return to the investors. Risk anomaly is an emerging concept figured out by Robert Haugen (1967) and in India it is only on its initial stage and now various studies is conducting to explore risk anomaly to diversify ones investment to take advantage of earning risk adjustment return. It is thus a concept which is contradictory to some of the main traditional theories like Capital Asset Pricing Model and risk return trade off. The direct relationship of risk and return is no more adequate in determining an efficient investment strategy. The portfolio of shares determines ones return from such investment. Two strategies used to Explore risk anomaly are 1) Low volatility portfolio and Minimum Variance portfolio Low volatility investment strategy is the collection of equally weighted stocks in the lowest volatile deciles against to the heavy market cap weighted portfolios. It is the most prominent tool in the bearish market where higher absolute return and risk adjusted return can achieve otherwise not possible. Risk anomaly thus increases

the return of investors even an investor holding the low volatile shares by a proper portfolio management. A detailed study is conducted to find the possibility of risk anomaly in Indian capital market is available. For the purpose of study it took 10 shares of different companies which are listed in NSE. The shares of different companies for the period of 11 years are taken for the study (2001-2011). The monthly averages of stock prices in the port folio of one investor is computed and compared. The shares taken for the study are a mix of high and low volatile security. Table:1 Average monthly returns and volatility of monthly returns for the tested period
P1 Average monthly returns Volatility of monthly returns 12.6% 11.2% 10.4% 10.1% 8.9% 8.6% 8.3% 7.2% 6.4% 5.1% 8.7% 1% P2 .89% P3 1.14% P4 1.25% P5 1.07% P6 1.49% P7 1.13% P8 1.19% P9 1.34% P10 1.72% index 1.2%

From the table given above it is clearly depicts that risk anomaly is a n efficient tool to increase the return of an investor. In the table volatility and the return from such share is compared. It is clearly understood that higher the volatility/risk lesser will be the return. Here evolve the practicability of risk anomaly, by using the low volatility anomaly one could reduces the risk and increases the return. Thus to reap the benefit of risk anomaly one should have a better portfolio of securities. This principle thus eliminates the traditional concept of risk and return. It is not only the risk which determines the return of security but there are other factors which im-

proves the return of an investor like effective portfolio diversification, selection of securities etc. This strategy always generates superior risk-adjusted returns in the longrun as compared to a high-volatility portfolio and the market portfolio. The success of this strategy depends on investment horizon of an investor. This strategy may work better in the long run over a full investment cycle or during a bear phase of the market as compared to a typical bull run where high volatility stocks tend to generate superior returns.

Reasons for low volatility anomaly One is left with a puzzling picture regarding the relationship between risk and return. One of the explanations for this anomaly is the lottery effect, where investors overpay for risk in a small set of stocks they feel would provide supernormal returns, and thus misses out the benefits of diversification. The lottery effect thus leads to effective lower returns in high-volatility stocks. This effect is similar to a lottery in which a large number of risk taking investors participate in very risky bets to make quick money. Another explanation is the winners curse. The highest bidding buyer often pays more for a stock than its true intrinsic value. The winner curse applies more to high volatile stock than low volatile stock. Conclusion The results found in the Indian markets are similar to those found in some other countries such as the US: the low-volatility portfolio strategy gives a higher absolute return over a long period than the high-volatility portfolio as well as the broad market index and it requires patience to reap its benefits.

References 1.Rambhia,rohan,Exploring risk anomaly in the Indian capital market research paper www.nseindia.in February 2012 2. Clarke, Roger, Harindra de Silva, and Steven Thorley. Minimum Variance Portfolios in the U.S. Equity Market. Journal of Portfolio Management, Fall 2006, pp. 1024. 3.Clarke, Roger, Harindra de Silva, and Steven Thorley. Exploring the Risk Anomaly in the Equity Market, Economics and Portfolio Strategy, December 2006