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Empirical Analysis of the Intertemporal Relationship between Downside Risk and Expected Returns: Evidence from Time‐varying Transition Probability Models
Author(s) -
Chen Cathy YiHsuan,
Chiang Thomas C.
Publication year - 2016
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/eufm.12079
Subject(s) - downside risk , economics , econometrics , markov chain , expected return , stock (firearms) , value at risk , empirical evidence , financial economics , risk management , portfolio , statistics , mathematics , finance , mechanical engineering , philosophy , epistemology , engineering
This paper examines the intertemporal relationship between downside risks and expected stock returns for five advanced markets. Using Value‐at‐Risk (VaR) as a measure of downside risk, we find a positive and significant relationship between VaR and the expected return before the world financial crisis (September 2008). However, when we estimate the model using a sample after this date, the results show a negative risk–return relationship. Evidence from a two‐state Markov regime‐switching model indicates that as uncertainty rises, the sign of the risk–return relationship turns negative. Evidence suggests that the Markov regime‐switching model helps to resolve the conflicting signs in the risk–return relationship.