The Case of “Less is More”: Modelling Risk-Preference with Expected Downside Risk

Mihály Ormos and Timotity Dusán ()
Additional contact information
Timotity Dusán: Department of Finance, Budapest University of Technology and Economics, Magyar tudosok krt 2., Budapest, Hungary

The B.E. Journal of Theoretical Economics, 2017, vol. 17, issue 2, 14

Abstract: This paper discusses an alternative explanation for the empirical findings contradicting the positive relationship between risk (variance) and reward (expected return). We show that these contradicting results might be due to the false definition of risk-perception, which we correct by introducing Expected Downside Risk (EDR). The EDR parameter, similar to the Expected Shortfall or Conditional Value-at-Risk, measures the tail risk, however, fits and better explains the utility perception of investors. Our results indicate that when using the EDR as risk measure, both the positive and negative relationship between expected return and risk can be derived under standard conditions (e. g. expected utility theory and positive risk-aversion). Therefore, no alternative psychological explanation or additional boundary condition on utility theory is required to explain the phenomenon. Furthermore, we show empirically that it is a more precise linear predictor of expected return than volatility, both for individual assets and portfolios.

Keywords: asset pricing; variance; conditional value at risk; expected downside risk; utility theory; behavioral finance (search for similar items in EconPapers)
JEL-codes: C53 C62 G02 G12 G17 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://doi.org/10.1515/bejte-2016-0100 (text/html)
For access to full text, subscription to the journal or payment for the individual article is required.

Related works:
Working Paper: The case of 'Less is more': Modelling risk-preference with Expected Downside Risk (2017)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bpj:bejtec:v:17:y:2017:i:2:p:14:n:8

Ordering information: This journal article can be ordered from
https://www.degruyter.com/journal/key/bejte/html

DOI: 10.1515/bejte-2016-0100

Access Statistics for this article

The B.E. Journal of Theoretical Economics is currently edited by Burkhard C. Schipper

More articles in The B.E. Journal of Theoretical Economics from De Gruyter
Bibliographic data for series maintained by Peter Golla ().