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Downside Correlation and Expected Stock Returns

47 Pages Posted: 9 Nov 2001  

Andrew Ang

BlackRock, Inc

Joseph Chen

University of California, Davis - Graduate School of Management

Yuhang Xing

Rice University

Date Written: March 2002

Abstract

If investors are more averse to the risk of losses on the downside than of gains on the upside, investors ought to demand greater compensation for holding stocks with greater downside risk. Downside correlations better capture the asymmetric nature of risk than downside betas, since conditional betas exhibit little asymmetry across falling and rising markets. We find that stocks with high downside correlations with the market, which are correlations over periods when excess market returns are below the mean, have high expected returns. Controlling for the market beta, the size effect, and the book-to-market effect, the expected return on a portfolio of stocks with the greatest downside correlations exceeds the expected return on a portfolio of stocks with the least downside correlations by 6.55% per annum. We find that part of the profitability of investing in momentum strategies can be explained as compensation for bearing high exposure to downside risk.

Notes: Previously titled Downside Risk and the Momentum Effect

Keywords: asymmetric risk, cross-sectional asset pricing, downside correlation, downside risk, momentum effect

JEL Classification: C12, C15, C32, G12

Suggested Citation

Ang, Andrew and Chen, Joseph and Xing, Yuhang, Downside Correlation and Expected Stock Returns (March 2002). EFA 2002 Berlin Meetings Presented Paper; USC Finance & Business Econ. Working Paper No. 01-25. Available at SSRN: https://ssrn.com/abstract=282986 or http://dx.doi.org/10.2139/ssrn.282986

Andrew Ang

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

Joseph S. Chen (Contact Author)

University of California, Davis - Graduate School of Management ( email )

One Shields Avenue
Davis, CA 95616
United States
(530) 752-7155 (Phone)
(530) 752-2924 (Fax)

Yuhang Xing

Rice University ( email )

6100 South Main Street
Houston, TX 7705-1892
United States

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