Bear Beta or Speculative Beta?—Reconciling the Evidence on Downside Risk Premium

Review of Finance, Forthcoming

55 Pages Posted: 9 Feb 2022 Last revised: 6 Apr 2022

See all articles by Tong Wang

Tong Wang

University of Oklahoma, Price College of Business

Date Written: January 28, 2022

Abstract

This paper develops a new approach to explain why risk factors constructed from option returns are priced in the stock market. We decompose an option- based factor into three main components and identify the one responsible for the beta-return relationship. Applying this method to the bear risk factor proposed by Lu and Murray (2019) reveals that the negative correlation between bear betas and stock returns does not reflect systematic risk premia. Instead, it represents an anomaly closely related to the betting-against-beta puzzle. We trace the root of this anomaly to disagreement concerning the aggregate stock market. Our work reconciles the conflicting evidence concerning downside risk by showing that it is not priced in the stock market while making a methodological contribution that helps accurately interpret option-based risk factors.

Keywords: downside risk, option return, anomaly, disagreement

JEL Classification: G11, G12, G13

Suggested Citation

Wang, Tong, Bear Beta or Speculative Beta?—Reconciling the Evidence on Downside Risk Premium (January 28, 2022). Review of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=4027995

Tong Wang (Contact Author)

University of Oklahoma, Price College of Business ( email )

307 West Brooks, Room 205A
Norman, OK 73019
United States
2132357250 (Phone)

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