A Novel Downside Risk Measure and Expected Returns
Several studies have found that the cross-section of stock returns reflects a risk premium for bearing downside risk; however, existing measures of downside risk have poor power for predicting returns. Therefore, this paper proposes a novel measure...
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Format: | Working Paper |
Language: | English |
Published: |
World Bank, Washington, DC
2019
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Online Access: | http://documents.worldbank.org/curated/en/524291563990594233/A-Novel-Downside-Risk-Measure-and-Expected-Returns http://hdl.handle.net/10986/32131 |
Summary: | Several studies have found that the
cross-section of stock returns reflects a risk premium for
bearing downside risk; however, existing measures of
downside risk have poor power for predicting returns.
Therefore, this paper proposes a novel measure of downside
risk, the ES-implied beta, to improve the prediction of the
cross-section of asset returns. The ES-implied beta explains
stock returns over the same period as well as the widely
used downside beta, but also has strong predictive power
over future returns. In the empirical analysis, although the
widely used downside beta shows a weak relation with future
expected returns, the ES-implied beta implies a
statistically and economically significant risk premium of
0.5 percent per month. The predictive power of the
ES-implied beta is not explained by the cross-sectional
effects from the CAPM beta, size, book-to-market ratio,
momentum, coskewness, cokurtosis or liquidity beta, nor does
it depend on the design of the empirical analysis. |
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