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Bear Beta and Its Pricing Implication: Evidence from the European Financial Market

Student: Tobi ezekiel Oladiran

Supervisor: Victoria Rodina

Faculty: Faculty of Economic Sciences

Educational Programme: Strategic Corporate Finance (Master)

Final Grade: 7

Year of Graduation: 2020

This research work examines the significance of the bear market risk, time variation in the probability of future bear market state, in the UK and European financial market. Since an Arrow-Debreu security (Arrow (1964), Debreu (1959)), being a theoretical abstraction, has no counterpart actually traded in financial markets, attempts are made to synthetically construct a state security following the Wachter's (2013) and the Lu and Murray (2019) approach. The outcome is a composite portfolio (AD Bear portfolio) built on traded options on Financial Times Stock Exchange 100 index performing in the period through June 2010 to June 2019. The AD portfolio pays off one unit of money if at expiration the market is in a bear state thus capturing exclusively left-tail market events. Then the AD Bear portfolio performance against a standard set of risk factors is examined. The findings reveal that AD Bear portfolio has a negative exposure to the market factor, as predicted. At the same time, it cannot be fully explained by the factors return from capital asset pricing model (CAPM), three (3) factors model from Fama and French (1993), five (5) factor model from Fama and French (2015) and momentum factor from Carhart (1997). The findings of this study share some commonalities with the findings of Lu and Murray (2019) which focus on the US market but the evidence for the UK and European market is somewhat weaker.

Full text (added November 4, 2020)

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