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

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