Downside Risk and the Momentum Effect
Stocks with greater downside risk, which is measured by higher correlations conditional on downside moves of the market, have higher returns. After controlling for the market beta, the size effect and the book-to-market effect, the average rate of return on stocks with the greatest downside risk exceeds the average rate of return on stocks with the least downside risk by 6.55% per annum. Downside risk is important for explaining the cross-section of expected returns. In particular of the profitability of investing in momentum strategies can be explained as compensation for bearing high exposure to downside risk.
- Stocks that are highly correlated with the market when the market declines have higher expected returns than stocks that are not highly...
Ang, Andrew, Joe Chen and Yuhang Xing. “Downside Risk." Review of Financial Studies 19 (2006): 1191-1239.