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Downside risks and the cross-section of asset returns

Journal article
Authors Adam Farago
R. Tedongap
Published in Journal of Financial Economics
Volume 129
Issue 1
Pages 69-86
ISSN 0304-405X
Publication year 2018
Published at Department of Economics
Pages 69-86
Language en
Links dx.doi.org/10.1016/j.jfineco.2018.0...
Keywords Generalized disappointment aversion, Downside risks, Cross-section, generalized disappointment aversion, stock returns, long-run, market, equilibrium, temporal behavior, currency markets, expected returns, consumption data, volatility, prices, Business & Economics, ristie aa, 1982, journal of financial economics, v10, p407
Subject categories Economics and Business

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. (C) 2018 Elsevier B.V. All rights reserved.

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