The Gain-Loss Spread: A New and Intuitive Measure of Risk

19 Pages Posted: 29 Nov 2008

Multiple version iconThere are 3 versions of this paper

Date Written: November 2008

Abstract

The standard deviation, arguably the most widely-used measure of risk, suffers from at least two limitations. First, the number itself offers little insight; after all, what is the intuition behind the square root of the average quadratic deviation from the arithmetic mean return? Second, investors tend to associate risk more with bad outcomes than with volatility. To overcome these limitations, this article introduces a new measure of risk, the gain-loss spread (GLS), which is both intuitive and based on magnitudes that investors consider relevant when assessing risk. The evidence reported below shows that the GLS is highly correlated with the standard deviation, thus providing basically the same information about risk; and more correlated to mean returns than both the standard deviation and beta, thus providing a tighter link between risk and return.

Keywords: risk, gain-loss spread, downside risk

JEL Classification: G10, G12

Suggested Citation

Estrada, Javier, The Gain-Loss Spread: A New and Intuitive Measure of Risk (November 2008). Available at SSRN: https://ssrn.com/abstract=1308103 or http://dx.doi.org/10.2139/ssrn.1308103

Javier Estrada (Contact Author)

IESE Business School ( email )

IESE Business School
Av. Pearson 21
Barcelona, 08034
Spain
+34 93 253 4200 (Phone)
+34 93 253 4343 (Fax)

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