Modeling Market Downside Volatility
Review of Finance (2013), 17(1), 443-481, doi: 10.1093/rof/rfr024
52 Pages Posted: 9 Mar 2010 Last revised: 7 Jan 2013
Date Written: March 1, 2011
We propose a new methodology for modeling and estimating time-varying downside risk and upside uncertainty in equity returns and for assessment of risk-return trade-off in financial markets. Using the salient features of the binormal distribution, we explicitly relate downside risk and upside uncertainty to conditional heteroscedasticity and asymmetry through binormal GARCH (BiN-GARCH) model. Based on S&P 500 and international index returns, we find strong empirical support for existence of signicant relative downside risk, and robust positive relationship between relative downside risk and conditional mode.
Keywords: Binormal distribution, Downside risk, Intertemporal CAPM, GARCH, Relative downside volatility, Risk-return trade-off, Upside uncertainty.
JEL Classification: C22, C51, G12, G15
Suggested Citation: Suggested Citation