The Case of “Less is More”: Modelling Risk-Preference with Expected Downside Risk
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Mihály Ormos
und
Dusán Timotity
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.
Funding statement: Bolyai Foundation, (Grant /Award Number: ‘BO/00144/15/9ʹ)
Acknowledgements
We would like to gratefully acknowledge the valuable comments and suggestions of two anonymous referees that contribute to a substantially improved paper. Mihály Ormos acknowledges that this study was supported by the János Bolyai Research Scholarship of the Hungarian Academy of Sciences.
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Artikel in diesem Heft
- Research Articles
- Optimal Monetary Policy in an Overlapping Generations Model with Search Theoretic Monetary Exchange
- Getting a Job through Unemployed Friends: A Social Network Perspective
- Dynamic Stability of Post-Keynesian Pricing
- A Nonspeculation Theorem with an Application to Committee Design
- Information Acquisition in the Era of Fair Disclosure: An Application of Asymmetric Awareness
- Privatization Neutrality Theorem in Free Entry Markets
- Strong Forward Induction
- The Case of “Less is More”: Modelling Risk-Preference with Expected Downside Risk
- Stability of Equilibrium Outcomes under Deferred Acceptance: Acyclicity and Dropping Strategies
- Notes
- A Height-Based Multidimensional Extension of the Lorenz Preorder for Integer-Valued Distributions
Artikel in diesem Heft
- Research Articles
- Optimal Monetary Policy in an Overlapping Generations Model with Search Theoretic Monetary Exchange
- Getting a Job through Unemployed Friends: A Social Network Perspective
- Dynamic Stability of Post-Keynesian Pricing
- A Nonspeculation Theorem with an Application to Committee Design
- Information Acquisition in the Era of Fair Disclosure: An Application of Asymmetric Awareness
- Privatization Neutrality Theorem in Free Entry Markets
- Strong Forward Induction
- The Case of “Less is More”: Modelling Risk-Preference with Expected Downside Risk
- Stability of Equilibrium Outcomes under Deferred Acceptance: Acyclicity and Dropping Strategies
- Notes
- A Height-Based Multidimensional Extension of the Lorenz Preorder for Integer-Valued Distributions
