A Novel Downside Risk Measure and Expected Returns

33 Pages Posted: 25 Jun 2019

Multiple version iconThere are 2 versions of this paper

Date Written: June 19, 2019

Abstract

A number of studies have found that the cross-section of stock returns reflects a risk premium for bearing downside risk; however, existing measures of downside risk have poor power for predicting returns. Therefore, this paper proposes a novel measure of downside risk, the ES-implied beta, to improve the prediction of the cross-section of asset returns. The ES-implied beta explains stock returns over the same period as well as the widely used downside beta,but also has strong predictive power over future returns. In the empirical analysis, while the widely used downside beta shows a weak relation with future expected returns, the ES-implied beta implies a statistically and economically significant risk premium of 0.5% per month. The predictive power of the ES-implied beta is not explained by the cross-sectional effects from the CAPM beta, size, book-to-market ratio, momentum, coskewness, cokurtosis or liquidity beta,nor does it depend on the design of the empirical analysis.

Keywords: Downside Risk, Risk-return Relation, Prediction

JEL Classification: C15, C31, G17, G12

Suggested Citation

Liu, Jinjing, A Novel Downside Risk Measure and Expected Returns (June 19, 2019). Available at SSRN: https://ssrn.com/abstract=3406944 or http://dx.doi.org/10.2139/ssrn.3406944

Jinjing Liu (Contact Author)

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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