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Theses Doctoral

Essays on Asset Pricing and Downside Risk

Giovannetti, Bruno Cara

This dissertation contributes to the recent and diverse literature on the relation between downside risk and asset prices. In chapter one, we use a famous quote among professional investors, "focus on the downside, and the upside will take care of itself", to motivate a representative consumer-investor who only cares about the downside. The consumption-based asset pricing model that emerges from this idea explains the main existing puzzles found within the asset pricing literature. These include the equity premium and the risk-free rate puzzles, the countercyclicality of the equity premium and the procyclicality of the risk-free rate. The model is parsimonious, requiring only three preference-related parameters: the time discount factor, the elasticity of intertemporal substitution, and the downside risk aversion. When we use the model to understand the relation between returns and consumption in the US, we find that the fitted parameter values are consistent with what is expected from the micro foundations. In chapter two, we show that the model proposed in chapter one can also explain the financial puzzles in other developed countries. This is an important step in the empirical validation of the model. The estimated parameters are robust across highly capitalized countries and qualitatively close to the ones obtained for the US. Moreover, the risk measure under the quantile utility model can better justify the differences in risk premia across countries when compared to the risk measure under the expected utility model. In chapter three, we evaluate the effect of margin requirements on asset prices, an additional channel for the relation between downside risk and prices. We provide evidences of the existence of an aggregate margin-related premium in the economy. In particular, we show that (i) a margin-related factor is able to predict future excess returns of the S&P 500 and (ii) stocks with high betas on the margin-related factor pay on average higher returns compared those with low margin betas. These result are important not only to understand asset prices, but also the unconventional polices implemented by the Fed during the great recession of 2007-2010. Although data on margin requirements for the S&P 500 futures are publicly available, it is in general very hard to obtain information on margins for other assets. Given that, we also propose a nonparametric model for estimating margins as a function of the asset's value at risk. This is theoretically justifiable and has good empirical results.



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More About This Work

Academic Units
Thesis Advisors
Kristensen, Dennis
Ph.D., Columbia University
Published Here
April 29, 2011