The Impact of Upside and Downside Risk on Expected Stock Returns: Across Firm Size and Value Measures

23 Pages Posted: 9 Sep 2011 Last revised: 4 Jan 2012

See all articles by Stephen P. Huffman

Stephen P. Huffman

University of Wisconsin Oshkosh

Cliff R. Moll

University of Wisconsin - Oshkosh

Date Written: September 7, 2011

Abstract

We investigate the relation between various alternative risk measures and future daily returns using a sample of firms over the 1988-2009 time period. Previous research indicates that returns are not normally distributed and that investors seem to care more about downside risk than total risk. Motivated by these findings and the lack of research on upside risk, we model the relation between future returns and risk measures and investigate the following questions: Are investors compensated for total risk? Is the compensation for downside risk different than the compensation for upside risk? and which measure of risk (i.e., upside, downside, or total) is most important to investors? We find that, although investors seem to be compensated for total risk, measures of downside risk, such as the lower partial moment, better explain future returns. Further, when downside and upside risk are modeled simultaneously, investors seem to care only about downside risk. Our findings are robust to the addition of control variables, including prior returns, size, book-to-market ratio of equity (B/M), and leverage. We also find evidence of short-run mean reversals in daily returns. Our findings are important because we document a positive risk-return relationship, using both total and downside risk measures; however, we find that investors are concerned more with downside risk than total risk.

Keywords: alternative risk measures

JEL Classification: G12

Suggested Citation

Huffman, Stephen P. and Moll, Cliff R., The Impact of Upside and Downside Risk on Expected Stock Returns: Across Firm Size and Value Measures (September 7, 2011). Midwest Finance Association 2012 Annual Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1924048 or http://dx.doi.org/10.2139/ssrn.1924048

Stephen P. Huffman (Contact Author)

University of Wisconsin Oshkosh ( email )

800 Algoma Blvd
Oshkosh, WI 54901
United States
9202330196 (Phone)
9204247413 (Fax)

HOME PAGE: http://www.uwosh.edu/home

Cliff R. Moll

University of Wisconsin - Oshkosh ( email )

800 Algoma Blvd.
Oshkosh,, WI 54901
United States

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