Downside risk and stock returns in the G7 countries: An empirical analysis of their long-run and short-run dynamics

Chen, C. Y.-H. , Chiang, T. C. and Härdle, W. K. (2018) Downside risk and stock returns in the G7 countries: An empirical analysis of their long-run and short-run dynamics. Journal of Banking and Finance, 93, pp. 21-32. (doi: 10.1016/j.jbankfin.2018.05.012)

Abstract

Any risk-return tradeoff analysis in aggregate equity markets relies on appropriate measures of risk, in most studies based on (co-)variance relations. Consequently, in integrated global markets, country-specific expected return is priced with a world price of covariance risk. This study relates domestic excess stock returns to the world downside risk. Evidence shows that downside tail risk (as a multiplier of volatility) has long memory cointegration properties; hence, the underlying risk aversion behavior in an integrated market is associated with the conditional quantile ratio, the correlation of stock returns, and the cointegrating coefficient of downside risk. Our empirical results based on G7 countries indicate that investors are averse to downside risk, which via Cornish–Fisher expansions is related to higher moment risk and interpretable in a utility-based decision framework.

• Item Type: Articles
• Additional Information: The authors gratefully acknowledge financial support from the Deutsche Forschungsgemeinschaft through SFB 649 "Economic Risk" and IRTG 1792 "High Dimensional Non Stationary Time Series".
• Status: Published
• Refereed: Yes
• Glasgow Author(s) Enlighten ID: Chen, Professor Cathy Yi-Hsuan
• Authors: Chen, C. Y.-H., Chiang, T. C., and Härdle, W. K.
• College/School: College of Social Sciences > Adam Smith Business School > Accounting and Finance
• Journal Name: Journal of Banking and Finance
• Publisher: Elsevier
• ISSN: 0378-4266
• ISSN (Online): 1872-6372
• Published Online: 26 May 2018