Downside Risk in Emerging Markets

Abstract:     
This paper investigates the relation between downside risk and expected returns on the aggregate stock market in an international context. Nonparametric and parametric Value at Risk (VaR) are used as measures of downside risk to determine the existence and significance of a risk-return tradeoff. Using market return data from 27 emerging countries, fixed-effects panel data regressions provide evidence for a significantly positive relationship between monthly expected market returns and downside risk. This result is robust after controlling for aggregate dividend yield, price-to-earnings ratio and price-to-cash flow ratio. The relationship between expected returns and downside risk is much weaker for developed markets. Indeed, it vanishes when control variables are included in the downside risk-return specification. These results continue to hold when we use a different emerging market classification system, an alternative regression methodology and exclude extreme returns.

Number of Pages in PDF File: 42

Keywords: downside risk, value at risk, risk-return tradeoff, emerging markets

JEL Classification: G12, G15

Accepted Paper Series