Baryonic Beta Dynamics: An Econophysical Model of Systematic Risk

Abstract

This essay seeks to rehabilitate the capital asset pricing model by splitting beta, the basic unit of systematic risk, into subatomic (or “baryonic”) components. By analogy to quantum chromodynamics and other aspects of the Standard Model of particle physics, this essay bifurcates beta on either side of mean returns and into distinct components reflecting relative volatility and correlation, as well as cash-flow and discount-rate effects. Splitting the atom of systematic risk answers some of the most troubling anomalies and puzzles in finance, including abnormal returns on small-cap and value stocks, the low-volatility anomaly, and the equity premium puzzle.