We examine the presence of a premium for bear market risk – time-variation in the probability of future bear market states – in the cross-section of hedge fund returns. We measure bear market risk using the returns of a bear spread portfolio orthogonalized with respect to the market and capture individual hedge fund exposure to bear market risk by its bear beta. We find that the lowest bear beta quintile of hedge funds – funds whose trading profile is more associated with selling bear market insurance – outperforms the highest bear beta quintile of hedge funds – funds whose trading profile is more associated with buying insurance – by 0.58% per month on average. The negative relation between bear beta and future hedge fund returns is statistically significant after controlling for a large set of fund characteristics and risk exposures. This relation remains negative during realized market crashes but turns positive during periods of increasing concerns about future bear market states, which is consistent with our risk-based explanation. 

JEL Classification: G11, G12, G23
Keywords: hedge funds, bear market risk, Bear portfolio, bear beta.​