Downside Risk Aversion of Style Investors

Nowadays, the problem of explaining market anomalies is very popular. The conventional risk measures are not able to explain the returns of market anomalies. This means that either market is imperfect and effective market hypothesis (EMH) does not hold, or that these risk measures cannot reveal all the risks. In this paper, I further modify Downside-Risk CAPM (DR-CAPM). I look for the market recessions such as market falls for consecutive periods, and investigate whether these consecutive falls have some explanatory power. The results of this paper provide evidence that it is less attractive for investors to have assets that are strongly correlated with the market during long recessions than during just short or beginning recessions. As a result, investors require higher risk premiums for the first group of assets. The results are robust and statistically significant for returns of different investment strategies in the US and globally. In this study, I also find a new pattern of the downside market risk premium, which is associated with the number of previous values of the market returns that investors take into account in order to calculate the average market return. I also provide an evidence in favor of the hypothesis that investors use the average market return of shorter period, e.g. 12 months, as the reference point rather than that of a longer period.