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Downside risks and the cross-section of asset returns

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  • Farago, Adam
  • Tédongap, Roméo

Abstract

In an intertemporal equilibrium asset pricing model featuring disappointment aversion and changing macroeconomic uncertainty, we show that besides the market return and market volatility, three disappointment-related factors are also priced: a downstate factor, a market downside factor, and a volatility downside factor. We find that expected returns on various asset classes reflect premiums for bearing undesirable exposures to these factors. The signs of estimated risk premiums are consistent with the theoretical predictions. Our most general, five-factor model is very successful in jointly pricing stock, option, and currency portfolios, and provides considerable improvement over nested specifications previously discussed in the literature.

Suggested Citation

  • Farago, Adam & Tédongap, Roméo, 2018. "Downside risks and the cross-section of asset returns," Journal of Financial Economics, Elsevier, vol. 129(1), pages 69-86.
    • Handle: RePEc:eee:jfinec:v:129:y:2018:i:1:p:69-86
    DOI: 10.1016/j.jfineco.2018.03.010
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    12. Jozef Barunik & Matej Nevrla, 2022. "Common Idiosyncratic Quantile Risk," Papers 2208.14267, arXiv.org, revised Nov 2024.
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    23. Mirco Rubin & Dario Ruzzi, 2020. "Equity Tail Risk in the Treasury Bond Market," Papers 2007.05933, arXiv.org.
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    More about this item

    Keywords

    Generalized disappointment aversion; Downside risks; Cross-section;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C31 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions; Social Interaction Models
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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