Asymmetric Systematic Risk and Risk Premiums Under a Regime-Switching Model

Abstract

The purpose of this thesis is to identify asymmetry in stocks’ systematic risk and market risk premiums under different financial market regimes. It is assumed that there are two unobserved regimes, bull and bear markets, in the U.S. stock market, which follow a hidden Markov process. A sample of 597 firms that are traded on multiple U.S. stock exchanges from January 1986 to October 2021 is used to test the hypotheses that systematic risk and market risk premiums are asymmetric in different market regimes. It is found that there is a strong asymmetry in the stocks’ systematic risk under both the extended CAPM and the Fama and French three-factor model setting. To test asymmetric market risk premiums, the cross-sectional regression is used and finds evidence that supports asymmetric market risk premium in both the extended CAPM and the Fama and French three-factor model.