127 Pages Posted: 20 Nov 2016 Last revised: 26 Sep 2018
Date Written: November 1, 2017
We test whether bear market risk - time-variation in the probability of future bear market states - is priced. We construct an Arrow-Debreu security that pays off in bear market states (AD Bear) from traded S&P 500 index options and use its returns to measure bear market risk. We find that bear beta (exposure to bear market risk) has a strong relation with expected stock returns that is robust, persistent, and remains strong among liquid and large stocks. Historical bear beta also predicts future bear market risk exposure. We conclude that bear market risk is priced in the cross-section of stock returns.
Keywords: Arrow-Debreu State Prices, Bear Beta, Bear Market Risk, Downside Risk, Factor Models
JEL Classification: G11, G12, G13, G17
Suggested Citation: Suggested Citation