Downside Risk Aversion, Fixed Income Exposure, and the Value Premium Puzzle

Abstract

The value premium substantially reduces for downside risk averse investors with a substantial fixed income exposure, such as insurance companies and pension funds. Growth stocks are attractive to these investors because they offer a good hedge against a bad bond performance. This result holds for evaluation horizons of around one year. Our findings cast doubt on the practical relevance of the value premium for such investors and reiterates the importance of the choice of the relevant test portfolio, risk measure and investment horizon in empirical tests of market efficiency and equilibrium.

Keywords: downside risk, semi-variance, interest rates, fixed income, value premium, asset pricing, behavioral finance, bond returns

JEL Classification: G11, G12