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Higher Co-Moments and Downside Beta in Asset Pricing

Author

Listed:
  • Imran Umer Chhapra

    (Shaheed Zulfikar Ali Bhutto Institute of Science and Technology (SZABIST), Karachi, Sindh 75600, Pakistan)

  • Muhammad Kashif

    (Shaheed Zulfikar Ali Bhutto Institute of Science and Technology (SZABIST), Karachi, Sindh 75600, Pakistan)

Abstract

The Capital Asset Pricing Model (CAPM) assumes a linear relationship between an assetís return and financial market. However, empirical invalidity of linearity of returns has given birth to other CAPM models. Therefore, this study aims to examine the implication of preference by a risk-averse investor for higher moments and downside risk as investors are assumed to be prudent, temperate and cautious and prefer firms with negative co-skewness, positive co-kurtosis, and downside risk as they yield higher risk premium. To empirically test these theoretical assumptions data of all 901 firms (listed and delisted) in Pakistan Stock Exchange (PSX) from 2000 to 2016 have been used. Decile portfolios are constructed for cross-sectional and time series analysis. Generalized Method of Moments (GMM) and Wald Test are applied to check the robustness of results. The results indicate that co-skewness, co-kurtosis and downside beta are important risk factors but only downside beta is genuinely priced over and above what co-variance risk can explain and CAPM does not significantly capture market risk premium indicating the existence of other risk measures in PSX. The findings can help investors in formulating investment strategies for constructing well-diversified and efficient portfolios and can enable firm managers to take appropriate capital budgeting decisions by appropriately costing equities.

Suggested Citation

  • Imran Umer Chhapra & Muhammad Kashif, 2019. "Higher Co-Moments and Downside Beta in Asset Pricing," Asian Academy of Management Journal of Accounting and Finance (AAMJAF), Penerbit Universiti Sains Malaysia, vol. 15(1), pages 129-155.
    • Handle: RePEc:usm:journl:aamjaf01501_129-155
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    References listed on IDEAS

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    1. Rutkowska-Ziarko, Anna & Markowski, Lesław & Pyke, Christopher & Amin, Saqib, 2022. "Conventional and downside CAPM: The case of London stock exchange," Global Finance Journal, Elsevier, vol. 54(C).

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