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Risk Aversion with Local Risk Seeking and Stock Returns: Evidence from the UK Market
Author(s) -
Kassimatis Konstantinos
Publication year - 2011
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/j.1468-5957.2011.02243.x
Subject(s) - downside risk , economics , risk premium , capital asset pricing model , financial economics , stock (firearms) , stochastic dominance , portfolio , arbitrage , equity premium puzzle , market portfolio , monetary economics , econometrics , mechanical engineering , engineering
Abstract: Post and Levy (2005) find that investors are risk averse for losses and risk seekers for gains and that stocks which exhibit low risk in bear markets and high potential for gains in bull markets may demand a premium. The present study examines if this type of risk preference creates a premium in UK stock prices using a third‐degree stochastic dominance test. We find that an arbitrage portfolio long on stocks with low past downside risk in bear markets and high past upside potential in bull markets and short on stocks with high past downside risk in bear markets and low past upside potential in bull markets generates a premium of 2.89% per month. This premium cannot be explained by the CAPM or the Fama and French 4‐factor model, but it exhibits significant similarities to the momentum premium.