IDEAS home Printed from https://ideas.repec.org/a/eee/ecmode/v44y2015icp86-96.html
   My bibliography  Save this article

Robust analysis for downside risk in portfolio management for a volatile stock market

Author

Listed:
  • Ayub, Usman
  • Shah, Syed Zulfiqar Ali
  • Abbas, Qaisar

Abstract

Variance and downside risk are different proxies of risk in portfolio management. This study tests mean–variance and downside risk frameworks in relation to portfolio management. The sample is a highly volatile market; Karachi Stock Exchange, Pakistan. Factors affecting portfolio optimization like appropriate portfolio size, portfolio sorting procedure, butterfly effect on the choice of appropriate algorithms and endogeneity problem are discussed and solutions to them are incorporated to make the study robust. Results show that downside risk framework performs better than Markowitz mean–variance framework. Moreover, this difference is significant when the asset returns are more skewed. Results suggest the use of downside risk in place of variance as a measure of risk for investment decisions.

Suggested Citation

  • Ayub, Usman & Shah, Syed Zulfiqar Ali & Abbas, Qaisar, 2015. "Robust analysis for downside risk in portfolio management for a volatile stock market," Economic Modelling, Elsevier, vol. 44(C), pages 86-96.
  • Handle: RePEc:eee:ecmode:v:44:y:2015:i:c:p:86-96
    DOI: 10.1016/j.econmod.2014.10.001
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0264999314003563
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Estrada, Javier, 2002. "Systematic risk in emerging markets: the," Emerging Markets Review, Elsevier, vol. 3(4), pages 365-379, December.
    2. Bawa, Vijay S., 1975. "Optimal rules for ordering uncertain prospects," Journal of Financial Economics, Elsevier, vol. 2(1), pages 95-121, March.
    3. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    4. Lakonishok, Josef & Shleifer, Andrei & Vishny, Robert W, 1994. " Contrarian Investment, Extrapolation, and Risk," Journal of Finance, American Finance Association, vol. 49(5), pages 1541-1578, December.
    5. Javed Iqbal & Robert Brooks & Don Galagedera, 2010. "Multivariate tests of asset pricing: simulation evidence from an emerging market," Applied Financial Economics, Taylor & Francis Journals, vol. 20(5), pages 381-395.
    6. Chunhachinda, Pornchai & Dandapani, Krishnan & Hamid, Shahid & Prakash, Arun J., 1997. "Portfolio selection and skewness: Evidence from international stock markets," Journal of Banking & Finance, Elsevier, vol. 21(2), pages 143-167, February.
    7. Zhou, Guofu, 1993. " Asset-Pricing Tests under Alternative Distributions," Journal of Finance, American Finance Association, vol. 48(5), pages 1927-1942, December.
    8. Michael C. Jensen, 1968. "The Performance Of Mutual Funds In The Period 1945–1964," Journal of Finance, American Finance Association, vol. 23(2), pages 389-416, May.
    9. John Y. Campbell, 2001. "Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk," Journal of Finance, American Finance Association, vol. 56(1), pages 1-43, February.
    10. Fama, Eugene F., 1998. "Market efficiency, long-term returns, and behavioral finance," Journal of Financial Economics, Elsevier, vol. 49(3), pages 283-306, September.
    11. Devinaga Rasiah, 2012. "Post-modern portfolio theory supports diversification in an investment portfolioto measure investment’s performance," Journal of Finance and Investment Analysis, SCIENPRESS Ltd, vol. 1(1), pages 1-3.
    12. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, March.
    13. Jean-Marie Dufour & Lynda Khalaf & Marie-Claude Beaulieu, 2003. "Exact Skewness-Kurtosis Tests for Multivariate Normality and Goodness-of-Fit in Multivariate Regressions with Application to Asset Pricing Models," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 65(s1), pages 891-906, December.
    14. Robert A. Korajczyk & Ronnie Sadka, 2004. "Are Momentum Profits Robust to Trading Costs?," Journal of Finance, American Finance Association, vol. 59(3), pages 1039-1082, June.
    15. Fishburn, Peter C, 1977. "Mean-Risk Analysis with Risk Associated with Below-Target Returns," American Economic Review, American Economic Association, vol. 67(2), pages 116-126, March.
    16. John L. Evans & Stephen H. Archer, 1968. "Diversification And The Reduction Of Dispersion: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 23(5), pages 761-767, December.
    17. Bawa, Vijay S. & Lindenberg, Eric B., 1977. "Abstract: Capital Market Equilibrium in a Mean-Lower Partial Moment Framework," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 635-635, November.
    18. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, vol. 59(3), pages 667-686, May.
    19. Shanken, Jay, 1982. " The Arbitrage Pricing Theory: Is It Testable?," Journal of Finance, American Finance Association, vol. 37(5), pages 1129-1140, December.
    20. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
    21. Estrada, Javier, 2007. "Mean-semivariance behavior: Downside risk and capital asset pricing," International Review of Economics & Finance, Elsevier, vol. 16(2), pages 169-185.
    22. Daniel, Kent & Titman, Sheridan, 1997. " Evidence on the Characteristics of Cross Sectional Variation in Stock Returns," Journal of Finance, American Finance Association, vol. 52(1), pages 1-33, March.
    23. Roll, Richard, 1981. "A Possible Explanation of the Small Firm Effect," Journal of Finance, American Finance Association, vol. 36(4), pages 879-888, September.
    24. Nawrocki, David N, 1996. "Market Dependence and Economic Events," The Financial Review, Eastern Finance Association, vol. 31(2), pages 287-312, May.
    25. Andrew Ang & Joseph Chen & Yuhang Xing, 2006. "Downside Risk," Review of Financial Studies, Society for Financial Studies, vol. 19(4), pages 1191-1239.
      • Andrew Ang & Joseph Chen & Yuhang Xing, 2005. "Downside risk," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
    26. Eric Jondeau & Michael Rockinger, 2006. "Optimal Portfolio Allocation under Higher Moments," European Financial Management, European Financial Management Association, vol. 12(1), pages 29-55.
    27. Post, G.T. & van Vliet, P., 2004. "Conditional Downside Risk and the CAPM," ERIM Report Series Research in Management ERS-2004-048-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    28. Harlow, W. V. & Rao, Ramesh K. S., 1989. "Asset Pricing in a Generalized Mean-Lower Partial Moment Framework: Theory and Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 285-311, September.
    29. Maria Vassalou & Yuhang Xing, 2004. "Default Risk in Equity Returns," Journal of Finance, American Finance Association, vol. 59(2), pages 831-868, April.
    30. Kroencke, Tim Alexander & Schindler, Felix, 2010. "Downside risk optimization in securitized real estate markets," ZEW Discussion Papers 10-034, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    31. Bawa, Vijay S. & Lindenberg, Eric B., 1977. "Capital market equilibrium in a mean-lower partial moment framework," Journal of Financial Economics, Elsevier, vol. 5(2), pages 189-200, November.
    32. Grootveld, Henk & Hallerbach, Winfried, 1999. "Variance vs downside risk: Is there really that much difference?," European Journal of Operational Research, Elsevier, vol. 114(2), pages 304-319, April.
    33. Cumova, Denisa & Nawrocki, David, 2011. "A symmetric LPM model for heuristic mean-semivariance analysis," Journal of Economics and Business, Elsevier, vol. 63(3), pages 217-236, May.
    34. Bekaert, Geert & Harvey, Campbell R., 1997. "Emerging equity market volatility," Journal of Financial Economics, Elsevier, vol. 43(1), pages 29-77, January.
    35. Ang, James S. & Chua, Jess H., 1979. "Composite Measures for the Evaluation of Investment Performance," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 14(02), pages 361-384, June.
    36. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    37. Elton, Edwin J & Gruber, Martin J, 1977. "Risk Reduction and Portfolio Size: An Analytical Solution," The Journal of Business, University of Chicago Press, vol. 50(4), pages 415-437, October.
    38. Statman, Meir, 1987. "How Many Stocks Make a Diversified Portfolio?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(03), pages 353-363, September.
    39. Joseph A. Atwood & Myles J. Watts & Glenn A. Helmers, 1988. "Chance-Constrained Financing as a Response to Financial Risk," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 70(1), pages 79-89.
    40. Haque, Mahfuzul & Kabir Hassan, M. & Varela, Oscar, 2004. "Safety-first portfolio optimization for US investors in emerging global, Asian and Latin American markets," Pacific-Basin Finance Journal, Elsevier, vol. 12(1), pages 91-116, January.
    41. Peter Byrne & Stephen Lee, 2000. "Risk reduction in the United Kingdom property market," Journal of Property Research, Taylor & Francis Journals, vol. 17(1), pages 23-46, January.
    42. Eugene F. Fama & Kenneth R. French, 2004. "The Capital Asset Pricing Model: Theory and Evidence," Journal of Economic Perspectives, American Economic Association, vol. 18(3), pages 25-46, Summer.
    43. Frahm, Gabriel & Wiechers, Christof, 2011. "On the diversification of portfolios of risky assets," Discussion Papers in Econometrics and Statistics 2/11, University of Cologne, Institute of Econometrics and Statistics.
    44. Narasimhan Jegadeesh, 2001. "Profitability of Momentum Strategies: An Evaluation of Alternative Explanations," Journal of Finance, American Finance Association, vol. 56(2), pages 699-720, April.
    45. Sofia B. Ramos & Jeroen K. Vermunt & José G. Dias, 2011. "When markets fall down: are emerging markets all the same?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 16(4), pages 324-338, October.
    46. Campbell Harvey & John Liechty & Merrill Liechty & Peter Muller, 2010. "Portfolio selection with higher moments," Quantitative Finance, Taylor & Francis Journals, vol. 10(5), pages 469-485.
    47. Attiya Y. Javid & Eatzaz Ahmad, 2008. "The Conditional Capital Asset Pricing Model: Evidence from Karachi Stock Exchange," PIDE-Working Papers 2008:48, Pakistan Institute of Development Economics.
    48. Ang, James S., 1975. "A Note on the E, SL Portfolio Selection Model," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 10(05), pages 849-857, December.
    49. Campbell R. Harvey & Akhtar Siddique, 2000. "Conditional Skewness in Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 55(3), pages 1263-1295, June.
    50. repec:hrv:faseco:30721347 is not listed on IDEAS
    51. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
    52. Hogan, William W. & Warren, James M., 1972. "Computation of the Efficient Boundary in the E-S Portfolio Selection Model," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 7(04), pages 1881-1896, September.
    53. De Bondt, Werner F M & Thaler, Richard H, 1987. " Further Evidence on Investor Overreaction and Stock Market Seasonalit y," Journal of Finance, American Finance Association, vol. 42(3), pages 557-581, July.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Philip A. Horvath & Amit K. Sinha, 2017. "Asymmetric reaction is rational behavior," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 41(1), pages 160-179, January.
    2. Sun, Xuelian & Liu, Zixian, 2016. "Optimal portfolio strategy with cross-correlation matrix composed by DCCA coefficients: Evidence from the Chinese stock market," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 444(C), pages 667-679.
    3. repec:spr:annopr:v:262:y:2018:i:2:d:10.1007_s10479-016-2137-0 is not listed on IDEAS
    4. repec:eee:ecmode:v:64:y:2017:i:c:p:449-464 is not listed on IDEAS
    5. repec:eee:ecmode:v:64:y:2017:i:c:p:60-71 is not listed on IDEAS

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:ecmode:v:44:y:2015:i:c:p:86-96. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: http://www.elsevier.com/locate/inca/30411 .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.