Asymmetric Beta Comovement and Systematic Downside Risk

Abstract

In this paper, we document evidence that downside betas tend to comove more than upside betas during a financial crisis, but upside betas tend to comove more than the downside betas during financial booms. We find that the asymmetry between Downside-Beta Comovement and Upside-Beta Comovement is the main driving force for market level skewness. An indicator called "Systematic Downside Risk" (SDR) is defined to characterize this asymmetry in the comovement of betas. This indicator negatively predicts future market returns. The SDR effectively forecasts future monthly stock market movements with an out-of-sample R-square above 2.27% relative to a strategy based on historical mean. An investor who timed the market using SDR would have obtained a Sharpe ratio gain of 0.206.

Keywords: Systematic Risk, Skewness, Predictability, Trading Strategies

JEL Classification: G11, G12, G14, G17