Safe Minus Risky: Do Investors Pay a Premium for Stocks that Hedge Stock Market Downturns?

54 Pages Posted: 10 Jul 2015 Last revised: 17 Dec 2015

See all articles by Nishad Kapadia

Nishad Kapadia

Tulane University - Finance & Economics

Barbara Ostdiek

Rice University - Jesse H. Jones Graduate School of Business

James Weston

Rice University - Jesse H. Jones Graduate School of Business

Morad Zekhnini

Michigan State University - The Eli Broad College of Business and The Eli Broad Graduate School of Management

Date Written: December 7, 2015

Abstract

Stocks that hedge against sustained market downturns — periods from peak to trough in S&P500 levels at the business cycle frequency — should have low expected returns, but they do not. We use ex-ante firm characteristics and covariances to construct a tradeable Safe Minus Risky (SMR) portfolio that hedges market downturns out-of-sample. Although downturns correspond to significant declines in GDP growth, SMR has significant positive average returns and four factor alphas (both about 0.75% per month). Risk-based models do not explain SMR’s returns, but mispricing does. Risky stocks are overpriced when sentiment is high, resulting in subsequent returns of -1% per month.

Keywords: Bear Markets, Expected Returns, Risk Factors

Suggested Citation

Kapadia, Nishad and Ostdiek, Barbara and Weston, James Peter and Zekhnini, Morad, Safe Minus Risky: Do Investors Pay a Premium for Stocks that Hedge Stock Market Downturns? (December 7, 2015). Available at SSRN: https://ssrn.com/abstract=2627848 or http://dx.doi.org/10.2139/ssrn.2627848

Nishad Kapadia

Tulane University - Finance & Economics ( email )

A.B. Freeman School of Business
7 McAlister Drive
New Orleans, LA 70118
United States
504-314-7454 (Phone)

Barbara Ostdiek

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States
713-348-5384 (Phone)
713-348-5251 (Fax)

James Peter Weston (Contact Author)

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005
United States
713-348-4480 (Phone)
713-348-6331 (Fax)

Morad Zekhnini

Michigan State University - The Eli Broad College of Business and The Eli Broad Graduate School of Management ( email )

East Lansing, MI 48824-1121
United States

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