Chapter
I
Itrtroduction to Downside Risk h Arset pricing
lJ.lrarqbbr
8lra.-.. dx.t$i 8ar
13 t -rtl (,|r.dr.
r.r.
r,a. ProbLs
r4 8..F.f
lr,I.
l
uL
8r.r....r
8tt
l}del
S.or.
re lanic.l goq
SartGhFdtld
lLDb.Entd!
h-q'*e
r.l. btrodqctiotr
A
$ibbl.
er
pricirs ood.t for
! nek netcr ot a @urry hs b... & !h of !d
ror rcs@hcB, rcldmi.ies, corpordc ,eag.u dd policyhakh
ltit .
'rcEst
PriDdily, asel priciq oodck sj.$ ns**ruh rt rioDshiD
,n o@r b msur vatB ,or
dc srrk.hold.s in nMc hrt.L!. Thcy h.lp i. pricing sbr.s Dorc
approprirr.ty
.nd in dricip.tinS portfotio risk for i.v.nou. Ille. mod.ts
*ptrjn rh. n.rtcr b.h.vior,
itE Mtlc of in!.sbsl .nd M b. p,volli for o insriidlonlj
dtud of 6m|M
nock. Momv.r. d.linc.ring mn of c.pj(rt for thc Fpi1lt
budg.tins i! ncce$iry lo
iiMe tlEh ori 6El Dricina hod.k @,!ibr!. in $n @ bdinS ro $iEblc mod.
of
trMcins Thousb rhcrc dc norc lhs one 6$d p,icing mod.ts bul
Capital A$el pricins
Modd d.v.lop.d by Sh{rp. (196a) wih its foud.rion
in Md(o*jEt 0912) Mod.n
Ponfolio Tb@ry is lb. nosl wid.t, used ,$d
lricins Dodelr. C&irat A$.r priciis
Mod.l is r sinst. 6sct prici,a nFdct *,hich is simple i.
@Mr ed ns Eal {,rd
(vo
applicrlions
Hone (2002)).
T}!. workr or Me*osilz (t952) Md Sh4e (t964)
h*r prccup,.o In!.sltD.il
otio'ality for D-y
jD fnMtd ertd.
MrkowiE (t952) trys founddion of
'tm(MpT) dd Shsp. 964) pEen6
Mod.n Ponfotio Th.ory
prjcing
0
(CAPL0
a
Mod.t
^.s.r
rwo hlror p,.mjss offi€fl.s
rl'e e sdl tc
Ddtcri Ho@!er, lh,. e obs.BilioDs !bou! o.s.
rh. arpliqtion
d. 6ndci.l
CaDnar
ofMpl.
rwo
in
lh6i.s ed
honly, Eenr criricism c.lts for cple.D.nl of
vridcc by doM.idc risk $ s.mnd
nohe.t h ns*-rctun @ly5is. Imldeion or dom.jde rjjt (DR)
hc r,id fob&ad
ror Posr-MPT od rcpraemcnl of CAPM by
dowNid€ risk bd.d CAPM (!hon
sr
ar.(2003)1.
E6 of MPI rurts whd
Metdje
cjd rhc ,orion dli pon,orio rhs, is onty
aDpmr.d on bdinianion of rcrun He sgucs
lh.l dE dcp.ndcnc. on filsl mo6.nt
lerds io !h. 6. of no pEf.EE
b.rwen divhi6.bt.
(|
952)
Dorrtotios
Morcover, h. emphisias thd a|l risk..Dan
fron
'6nh!, -d H^q
(2oor )
ad
Bmw a,r' (2mo
dd $ar sufurpds
lrsLmric nsk, e. dNeuified swry.
vri&e
h add.d .s seond DoFent
b i.tuh
in hn fanous
|
Mv -iim.work lhus
l.yii!
lh. fouddioi oi MPT. Ponfolio eldlion i b.sd on $. rdbd.tion of 6d No
monats dd covride of a$c 6uxir8 in €6cid torid or F tfotic. Eo*d.r,
d.tlmination of.pprcprhL podolios on cfiici.nl FoDtis is ! Dnbt.n i. b. sdtved.
Tobin (1958)
sugs*
an
\is 2-F6d s.patuioh ?t @r
rhal
4h
int6tor
hotds
@tbinatior of risk-6e. ed rhky ss.t! for utility-ndimizin! portfolio Capttol nnke!
/j,, (cML) which is llnslnt r,o.niciot nodi.r dclemir.s th. lDpmprilk ponrolios. ln
rhi s.y- orc g.rs 2-6Dd $p&.ri6 rll.a .quililriw .onditiN. CML EDEsdr. !M
of d.htld enslnprid od n* pEmi!f, for rbich M iir.stor is @hpcne&d. o'r
ihcse dHr.lic.l gmunds, li6| tgg.iad !!sl pflcirg nod.l is d.lcloped by tolt
cont ibuloB ird.Fnd.rtly. Thct frddorts e sihilu ud Esi on MrtNiE s MPI
utd fohii's |-FuA szpnation ftuo..k
CAPM n
TE mr
,.d.p..d.nllt d.v.loD€d
( 1962).
by
Shrp. (t964). LinrB
ll dc&minB Elarionship h.Nen risl
.U usyslemotic risk h.s b..n
.ficidtt
(1965).
Mo$i.
rd Eon win $.
(1966)
sd
condiiion rl$l
div.dincd. h dofin.s nst,Elun Elliiomhip !s
covli&G bci*c.r findci.l .$.ts and hdt.t portfolio. IG sinDljciry and con.na.ivd.$ ndd ir $p.rid ro b..h nuld.f.cbr od !bib8. nod.l!. This o b.
Eflel€d by its D.Dulriiy bd Bg. oud the Clob. CAPM s b. e[phistty
t.rr.s.ned lting reNny nulet ir)p (SML) which disph$ th. .rDectcd 6rc of rclurn
of u individul *uity or porfolio in tcru of ris*-lr@ nl. .nd r.htit. nsk of !
suty
or pordolio. SMI n
sho* th.n
.mpnid tun8tl
R.s:rinA on
iD*pliorl
$d
idal ebbds of
elr!
lhe
a*t
sound fot t st h.6 in
(G.bs€d.ra (1007)).
. cn
6!lgm.r.i
pricing
pDblm
fiEcnl @nomdics
y6
of iB
Evolvins
eu.d
ssumprions?, CAPM, in inni.l
bu
on.
contov.Eies
eis
to
oajor p.8p.cnv.si nnl D.Bpetive whjch cobplecly rcj.cb CAPM tlcorerislly
d
well
c
?mDni4lly Seold p.Bp..tiv. rlgus
tlr
pre*ncc
ofooFdic! Rsullihs i.
ctr.6ion of sinsl.-fa.ror CAPM into Duhnr&br CAPM llird n nFliv. G a kind
of a $llrion p@vid.r by tddresiDs th.ordical shortcominss of CAPM inlo modill.d
lcuions ofCAPM. Apd lom
G.tu
Srocl EichDg.,.vidcn€ iiom
mdtets widely r.jccs CAPM whilc .mersins
shtior
nek
rs Epon
ods d.vclop.d
nix.d EsuhJ. A po$ibl.
F6p.ciiw is EpLcing wiie by DR. Elding @Ddition of
ad mking singl. as.l pricina nodcl ll.xibl. r. &co6modd. rll typ6 of
und.r $nd
nomatiry
CA?M pldicis
li@
rel.tioNhip b.tscn nsk hd
r.nh
(ShaD. (1964)).
lhlt slock rtontly cdvlry with h&tet dd .xnibir high rduhs
Fudr*it llt, n t agn.d d[l
ii
ll inpli.s
@nt nDo@eols
signitsl
.nd Dosnih
whil.co nnU .mpnic.l .videM h onMrious dd nixcd ll is druh.d rh inlestot
Dcriod!
&
tbis cl.taonsftip is
indifr.Ht to upsi& $d douNid. nsk whilc
did@
i3
F.r?
sh.F ,tvcto6
rarlcts Th.y d. villin8 io D.y prcmilm
for sak giviry dowid. tisl pDr.dior i. bdisfi 6ds. Mo6v.r. MPI ud CAPM
asum. rha! inv.sloN e ist{v.E. ed li lc c& b. eid .boul nsl-wkins lnd ri,kmutd inwslou. Evide@ suss.ns lh.t inv.sb6 d b. nskavc6c, ndb.l or .v.n
isk$*kinl (Erlo. er zt (2003)).
DonEy difrcEnl bchivior dunrg bc& ond blll
di$ibutd thDs a€ommodrlinl
SrM.s dd emclio.s tunort e
MPT md CAPM a$ube lh.l iock rcons rr. nomally
,i6t
$!
iom.ni5 orly:
ns $d v{ida.
nondu i! obs.nc. or mhrlily (Eslmdt
(2002)) Thousn sop..io' idisriol tehniqE, b etu dr€ , addB thn pbbld bli
ooifmins nomlir! !o .mpnid ena n nol dccisiv. rtth.!,1hi5 condnion Ms d..p
inpotunr to be add.d
d
lhird cnd founh
ihediel ftr.Krk oaMPI s n eD.s qunErh udlily ro dd.min. .fiici.nr
iiontis. MoEov.r, rw.fbnework dsrn.s lhat inv.nor displays lnrc. n.jor
chrc&nsics: risk{v.jwri ronsialioi dd der6ing .b$l!r nsk .ve6io
inro
(DAR-A): Qu.drari. coDcsv. utiliry cupe d.picls invcsrof. b.halior but fclls shon or
For d*jk sd Abbs . oi(10r rA) 6d
lThdNumpljoB'o'ilEcoJein
liEdy by rid so llmds onlt
abh6
,
or(:01 rB)
c!r. trn!
&jm uDon @hins bliss poi (Ehon .r d(2m3)).
Wb difihnio. n &v.Ely .syn@rt, l.r8. d.FtuE ton mmdiry c.s MVcriLrion ro nil xd @ns.qu.Drly CAPM 6 wdl (Lr7 eol0)).
DARA
6
qu.dntic
inpond qwstio di$s wndh.. lo die..d CAPM! wndB ro ldd hish.r mlMts
or !.dspr r.dron n irto r multi-fr.rr nodcl! A po$iblc s|[ion n Eplenot of
unme by edivdim&, . speci.l c6e of domid. risl{, a inili.lly prcpos.d by
Mqk@iE ( 1952, 1959). Dowrd. rGk liv.s under shldo* ot MPT ed u.til rMny,
n n gaidns vid. @grnion @ng Mh.u
TBinB b*k b dly finics MPT n
pDpose! od n sill donitrr i.6.ld oflinD@ Likdis., norc lhd h.lf. c.nt!.y a!o,
ef.iy-liEt conc.fl n aho popos.i bd k ov.rloolcd for F moy ycm Cons.q*nlly,
An
tsl
Dricina ba!.d on
Roy ( 1952)
vdi.M @hI.Ed
dcb.r4 $rt inv.sror
@
for
ro
nFd.b b6!.! on
dol[d. ri* e
doM3i& nsk or si6plt, sar.ry rom
popult
distr a
Ii$
supponi4.vid.E b.hind iq nrt6 sn$
od il @ Ed.,i.e McrlowiE s Mv-fm.work ond CAPM S.@nd ihpoitnt
.nvohg. of SFjuL i tul ii do.!
@Dt.vc.. cAPMt aNnplion .$.ci.lly Tobit
'o1
l\gsE) 2-F td &pedion fleeh. SF-dl. i5 nol us.d in G*l pncing unlil Hogu ..d
Wmn Epl@ vei.M wilh sniwir€ in CAPM in 1974. Th€y 8iv. $. ftn or.irl
r.Fion of doMsid. risk b6cd CAPM (DCAPi4. s@nd brcattltrourn h hode by
B!*a in l9?5 who uses stoch.slic domime io d.rdninc n!k,
fmosr
B!w!
go.l. Royt s.f.ty Fid-ruI.,
(1975) dcv.lops
prxy
tor ndhnnic
donin.Er
(SD)
s t s.r Prnill
Monc
dd hLr, Fishbm il97?) *&nds it inio unlini&d scope or LPM. Brwa-FishbDn
LPM eMnD.ss.s .ll cl6*s ot i.v6loB: tuk{v.6q n3k.gtins od rnt{eutal.
(LPM)
Inv.s!06
& nst+v.e
6.ol li.d
ror lo$
!o condnion of
id
rh.y b@m. risk
mmalily md k Udible
ro
wt
E for sa.r. Addnion
inclld.3k M.ss rnd
llt, it
kunosis
a
dr.L bl, d6 d cry on . ..d tr. .f djsibdi.i
Frvi:0Encud{tdi*iblisfuc''m^niDvel
u aod!,
4n*{!!l96dD
6.sDNvidusohhidIopMsd|tE.|y!.s
4ll. Momv.r. B.M.nd Lindcnb.B (19?7) tun$d drsd syrfi.ric p.ni.l mobcirs
lo atynm.tric g.@.li4d @-LPM or CCLPM fd' ,n gd LPM 3r$oEs
Mmodrir8 aynndic dittsibutians Hoseg, LPM b.kd CAPM is i rodel lnd
ha b
b€
r.scd to give P.ight io il.
sl|a tl.r
Ev'd.nc.
CAPM des nor hold in d.v.lop.d ndk.ts likc UniEd
Wcsr.n Euope, cxcept for
5r,6
id
Gms
Slmt Exch.ne!. Howev.r, .Dergiry ma*els
prcvid. mixd E.ul|3. Evid.d for dMsid. risk b iill inmclu,iv. fd &v.lop.n
ruk r!whilcmqginsn.r*crs pbvidea morechrll.nsiD! srcundr Encrsins melas
4 D4E n.rr.l', hiShly vohrilc ltd infodcion rching ro slujn.s hd.n ir dK
tukcts n
oblain N.vdh?|.$, finecialhub3 oreocrging nelcis e
enich pDvid. mEl ud opporoninjc ftu3 rc$1i.8 jr fci8n
onen dimcuh
d*n slet schsss
10
di@i invcsh.'r (FDI). An aDpbpria! aled pncrng Dodci b pivonl for dEs. 6dk.r!
s n h.lps to d.v.lop deL achocps tthld wtuch inE.oE @ forae u
inv.slhenl ii lon! run5 A p*llir chs.cr.ristic of em.r8ins ntk rs is lh6t ln.$
d * n ro b. !todi.d individully a 4h 4.'3ing Dr*6 dcpicB r ltiqu.
bch.vior
Grnibsi
and Morys (201
1.2. SisDifi€nce of
Krnchi
I))
Stock ExchrDS€-PtlisttD
u
.n.4in3 rork l pohicolly,
siFlltumlly ond @rcoiolly. Th. e$by is o grt.*ay ro c..1nl Asi. utd lMtcd
ar cftsGd of Middl. E6r, Ii ha oft of olddl civilndion of world t owt .s l.ds
v.ll.y Civilbrid {ilh muli-lin8linic si.ry I is lh. vorld s sixth leg.sr Dopulous
@uDEy dd s.nty+r.nth iD Lhs of p@hding Dosct. P*ist n is d. foudinl
ncnbs oa or8rizrtioi of hleic C@p.6rion (OlC), n.nt r of U.iLd
Prkisli n !rcns th. coe4ihs msk.b Md
is
importinl
NdioB. Comonwdlth of N.tiontsd G20 dev.loping mrions Th. colntt, is
n.mber of lh. nucl.t chb of tne qorld.
7
.
Prlilbn
is
*od( forcc
r t2r0 billior @romt. tl hs rh. }!Dg6r popul.rim ri$ idth tdg.{
in *orld. lt n 6k n mons lop l.n ttgdl clccob rork ts in lhc wond
R.d GDP sbss .t 2.4% win srceo in asmuttlE ldt i! E@it d c L2y.. Oulpul in
!ffufetlrjng Flor i! 3% uhit. spis sior g'ous by 4.1%. pd @pila in@he rip
froD $1073 in 2009-t0 !o $1254 in 2orGI, by 16.9.. Th. counLy h$ on.
in6dtioMl socr dchdg. (KSE) &d No EgjoEl .rchds.s M.ly; tjl,orc sro.k
Exchdg. od hbnab.d sioc* EichMg.l
h foud.d in
RSE
1947
dd n th. tujor,
mosr tiquid
od 6.
onty inia,EtioMt slek
.rch&!. ofP.kist.. O' Nov.Dh.r t. t991, KSEIOo is inroduc.! dd slil &res s
bdhdrk inld for firmid rurcl. r\sE- lOO coDpris or nrjo, blq chips od n 6
b. safely a$mad lh.r rh.s. compqi.s fanty rcprcse $. toLl hdt.t. Io 1995.
KSEAll Sl'& Ind.x is .t$ huch.d 6 e ,uiti..y io KSE_I00 indcx. pEscnttx kSE
hc
fou D.rt t indi6 neryi KSE-|OO. KSE-AI Shu. Index, KSE-tO.nd KMt_30. A
()r.l of65l €npdi.s e tist d wi0! mdk.r c.pibtianion
of t35 bi ion oi Jutv lO.
r jDDoi.nr hdsin! ndt l lhoeins qTiot ch.ndqinics of uriqncrc$, high
r@w rd high prie voldit,ty. Due b so8 imriixios jrtc (SE, plribn.s
(SE
is
.6no6y h6 b..n iiclud.d in four dqsinB ndt ls tisl by
D.w Joncs TnG ti$
E E$nts dbs @noDi6 rh!,r @ dDe..d ro onribut ro
stobrt sDdrr. Tt . shows
di. €nfid.n
. d.l
innituiions
tik
KsE_prrnl.I havc
nlrr
.xFi.nc.s . high ruDovs .nd high pricc vor..itiry dDnns ft.
srdl 3i2. of O. m.rt.q n qFicnes hieh runov.. of 32t%
Eo$rb porenlid KSE
t$t d.cad.. D.spn $.
c
@mp.r€d !o IIYSE
bmov.r 6t% in 2006 KsE.lOo rjs.s by 650% rom 20or
ro 2005 whit. Dombrv
(Mmblil Sret Elch&gr TSSEJO).rp.roes r
n* of |lrr far Oc mc paoa;
This na*.s KSE a miqe .hcrging ndkcl.
hlviDg
Sine
it
inc.plion io 1992, KSEroolnd.r shows sk3dy pric.s titt2OO2. Il is d.clftd
6
B.r PcrfminS st@r M.tt l of rn. wortd by BEi|E w4t in 2002. H.@ford, n
sho*s ri* in pries n[ rid 2005, lhs a dm|ric f.]l only lo t@E le. Thc cxtl.n€
ol vol.tiliry in KSE is indiot d by 3,*inc .pied.s. Bullish $.Dd aDpds io h.vc
d.v.lop.d from 20021o 200t ed it busLd in Mmh 2005. This rrcnd is EfleLd in bdth
th. KSE-lm indd od tndins volb.s. Th! (SEr00 dp.i.Ms d uDecd.nlcd
D6oh.r 31, 2ma b l0J0l d MEfi | 5, 2005, llons wirh
rn im@. iD the valu. trrnd lbn mund 1300400 million ro t I -2 bittion Dc. d.y. Ii.
mtk t tums negalive in lh. sccond half of Msch, 2005 dd th. ind* drps ro $ low is
6.939 m April 12. 2005, ! d.clir. or 32.? D!rccnt from ils 0..1. Fo€i8n hlng pt.vlils
ris of 65rat non 6:
iill
2006
&d
I
E on
up ro JJ23 Mirrion
KSE crc$cs 15,000
@rdirg b Si.b Br'r
beicr IiBl tin. in
or
p*ist
(SBp).
ils hisrory in ADrit 2008. Hosever, iD
Mly
2008,
incrca$ inler.st r.t.3 ucxpelcdly io .ddre$ bish iDfl.tion, consguendy, KSE
d+lin.s sh.rply wnn r om-thid dDp t. irs ind* ud jn Augus! 2(xB tu fl@r t h!h.d
SBP
An
N.rd!
r@v.c
b.ding
k .llor.d
2G25% of i8 dcclirc in
r@h?s $35 billion by
12,000 poinri showinS
Evi'Lnc. is
z.ns
io
in
rhiLbL
illy
B@ o
i'dq
30,2010
rilt
2008
ud atwj'3tr, (SE
12,2m9, ToLl
turk r c.pibtiarion
D6.mbq t5,
Meh
dd in
D.ember 2OlO, ind.x sLadics lrouhd
unpell.l .nii!d. to*.rds volditiry nd runov.r.
for CAPM in KSE
pltitu
wilh rnsl Mjor 3tudy by Ahnrd
sd
Th.y us. CARCH.M nodct ro rcst risk-rcM rctarionship dd co.clDd.
stock r.tun fouowing cyclic.t rfld. Ahnad 6d e6im (2OO.r) olain l1!ll posirir.
1999.
e
DoE D@@unc.d cmpacd b n.g.rire ones for s. rurt.r lqb.l Dd
Dtuls (200) Eport p,t$a of mti@ nst-tu cla,rioNhiD. ,avid .d Ahmd
(2003) r.sr CAPM in erdniodr s.|li.8r Md dvcde us. or @ndilio.il{ApM
ihmkr
cooptcd ta convcntional CAPM. R.c.ntty, lqbat ,.al(2010) enpe. jingt..f.cror
CAIM witl Fm..Frcrch mutri-f..tor CAPM md @rclud. thar the ldLr ft 6oE
ruk.r Hovry,.I of l[d do Dor .ddE$ issue of inv.nor3
pcf.E.e of dowi& risk $B eiding rh.ir tudi6 o,ty io vsridc. 6 l@urc of
@nvhc'n3 ror P.tisl&
Tl'c lilentoa Evi.w rnd tne s6tur
M nppop
e
ofKSE-p.tjs6 e o ch.rging mut.r
3!gg€sL!
rlil
livor.t fo, bringins (SE .r p, wirn .h.ryjnS .nd
d.!.loped .qui9, mrrk.rs oflh. *orld. Ar apprcpri.r 6sel pricine mod.t ensurcs
a
rlilbk
6sct pricing modct
is
d. irv.sbdc lt .te h.lF i, Dricing risk in . tuii.3 md
n.L rh. n.turc of inv.shot Mod.h vo* consid.Ebty in slobt. odt.rs while f.itin
foEcrst for toD3
ondiliors, eks.nd bubbtes (SE_p.ljsLr is jnponDq siqu., rd its high
vol.rili9 dd high tuhoy.. provid. a ch3l.n8ing grcmd to r.$ d
.pproprate a$.l
volatle
1.3. R€se.r.h
Obj.ctiv.
Mv-6an*ork dd CAPM hav. mnrjbut.d
ro
rle tj.td of
$gr.6er
pnc,.g nod.t!
d. al$ th. Dost dislsd md diri.iud rEdcli m ,jn$c. (cr.iie od
HF.y (200t) rd Broud ..ol (200a)). D.v.top.d nark ts t&s.ty rcj6r capM.id
conseque.rryi Mv-firm.work. Ehdrjn! Dcrk.b e sti prl.d
vilh $. use lnd
how.ver, 0i.y
rppepn.Ln.$ of O!. po.rfotio rrFry ,.d ssd pnci4 nod.ts Tfi.n
chDcrf,ric of
un,qu. r.atorcs md hrd votaitity tud runovs m.kes rj.n
even rk.nd rbru
€nsid.d. eturion Mo@v.r, vuue s . tluurc of rik hs 6n. jong
a
*!y borh
i. Dortfolio rh6ry.nd .set pricirs, on rt. o6er hsd, is eos x qEsl6n.bt.
and
b b. addEscd .!d.nltt U.ds th.s circubsllnc.i cs..rcbeE srongty fcct
b
r.i a eibbl. Gs' pricins m.dct tom rh. .rinins Epository of nod4 ln.r add@s
bhc rsucs pertaining lo price !, ss.r hd 6 fl.xibt. enoush lo ecohhodate
nc.ds
lhe
Downsid. rtuk is a ,cncdy lhd hls ben proposcd
m..s
of
I
a rcpl.c.mc
iist (8.,! (t9?J)). Momv.i ssbprions ad ,! eics rct.r.d
ro
fi.
condiljon ot nonaliry olmor
b. ignord an N.r p,ici.g nod.t witiour retyin8 on
rp.cinc fom oi difibution n mt imilabl. in rfiis .E
of mod.6 €mpuids (Nawdki
( 99 I
)) Th? preseN. of risk-n.ur6l od ,ik-*trin! in v.nor is r po$jb it,ty rh.l caDn.r
t. rul.! out, rnd E$rjctingb dlk{ee inv.slor s no ooft. f6rbl. solurion
|
Abov.
.rr, M
ssr
pricinS
rod.l wilh !bov. ch.r&r.rj$ics n
.maBng hd*cl
lik KSD-P.listr.
This s$dy rims
b idcnlit
a suihbt. tiaglc
6sl
not r..rcd for in .xtiaordin..y
pricing ood.l for
ksE-pslisr.r
To
4hi.v. rhk objdiv., 66rty, rhi! srudy popos Eptlmd of wiM. by dovmjd.
risl G d o@!r. df risk n.n, thn sudt Equircs EsliDs th. doni@cc ot dowiridc
ob wioe in @l lllqtoD &d r!s.r prici.S io rstc rh. sludy robusl. lr h.tps
pricina t!. securirica ed a$cssi4 risk for st t.holde6
i.1h. slock hetet. Lslly,
'.
lh6 nudy lle pmD.$! io *nd aE dooin of invBror chtu..ijic! ud includ. .u
nsk
9p.3 lnd l*cls oI inv.$o6 noh nsk-rv.e to risk{c.&ing. Addnioully, rh.
noD.li' s proeriv.ly !ddes$d.
issu..f
1.4 Probleb StateD.rr
Tlli! study crilic.lly quBtions th. Be ot vdiMe !s ncdurc ol tul and adlosl.s
downside ris* s iB r?tllh6t in ss pncina. Low. p.ni,l
MoD..( pbx, of
downside risk dcvelopcd by Brsa (197t), n us.d !! a rcplac.D.nt.
I h.s ipo mlin
.,l'jbut Jt noni.li@ on ! +aific fom of dii.ibudon nDclo, M .gmodfud
or.ll Ce*bl
of inv.sr.d, Thft $udy ains to lcsl h*cr pdi.l Moftd b.sd
6$r pncDS hod.t in M .m.rgin8 tu]{d oling KsE_palirlln s , bpt.. Tfiis nldy
typcs
felss oi reo mjd i$B nm.tx is
hscd wilh KSE-P.tis&r, r.Dt&in8
lll@liodoonfolio oplimjaio!
eDpirical
This stody
6in*ork
of
i..
! iingt. 6!d
t sb di. nod?k bo$
of nom.rjiy fo,
veisF by
tur
Errhs of @mp.ni.s
downside rilk in .sel
th.orcridl fi.D.Mrt .nd a&r pricing
j.e
prioins modcl.
rh€djdl G sel .s mpiricat frMdork ro v.tidar.
n ed ndc ih. fts@h mo4 bbln pEvious studid conenr.r. r$i4 th.
hod.t
eDpnislb {d do nol vi? io omp.r vdimc &d do,nsid. nsk b!s.d ,od.h
theolaicqlly:.tn $.orcid toc{o( fln comp&j$n of downjdc flsr
is nad. with
v..i&e tunddk in .ss. altdrjo,Jportotjo oprinianjon usirg.iiciot idri.6 I.
in
.mpnjcal 6m.worL dowhsid.
ist dd veiMe bs.d
s.l
n. sr.ddicd
dd c,rid a 10 wh.ilicr 6ce .sd.ls hord ot nol. Addnion ltt, ricn Ddfo'fue i .t$
.ppnilcd HDinelly Thc
qkjioN !i!ug m:
pri.ins 6od.ls
'eeh
Do slocl rctobs
lii.d *ith ksE
d.picr .om.tity? If so rhen do.s
il
tc.d ro
sig.iiot diff.Enes bdw6 v.rioE ed dohsid. risk b.sd ,odck?
Dcs dMsid. ri l pcrfom stnifsrty b.rc' db Mv-tb.yort wh.n n is
lDpli.d
{o
podolio oprimizlri.n fo' KsE-p.tishn?
Co dosnside rilt fr.m.work b. .xthdcd rd ,U ItT.s of inv.sb4?
Do$ doMsid. risk francwort p.rfom b.tur on .mpnic.t I,ounds for KSE-
1,4.
S.op. of Study
'Ihis stldy d.fi'es s6p. ro dE* p&rd.r.u ot lh. rsrch
10 mk it noE
@npEh.ro'vc Thn snrdy @nffts iB.tf b si.8L ss.l pricins mod.t aod das noi
includ. nl|l;aelor nodcts. Ator s cnt dad of Albihg. pricinS Theoryr, rlt.v!it!bt.
a$el pncins 6dd.h lisl CAPM\ b.L lnong pioory f.cron. Morsvcr, n..rty a of
muhi-r&ror nodeh .E .xtcDsioDs of rirc sins,. ss.l bd.d CAPM. Thn study is tini&!
ad
s rni s1r|d! .dv@&s Eptchdr of vfjse wirh
doMsidc nsl a a n6uE of risL Thn stody is n.xibt. ud o ldd noE flcrots or
to sinsl.
pricina mod.l
6rk
it inEnemporil or cv.n cohditior.l DCAPM, if n€.dcd How.!.i, $is prcbt.n is
not .ddr.$.d in lhis rcs.&ch dD. ro rlr priD.D feE on a sinste as.t nodel
Additio lly, th. sp. of nudy rmtv.s mud ifiE roi. rss nd.ty: lhor?rist,
cmpiri€l dd dab Th.s. ms ee di$ussd iD lh. fotto*irs suDstroDs
1,4.1, Theor€ti@l Scopc
Th.oEtielly, rhis $dy anfir.s to
nomahty. ryles of inv.sioE
i
{uc brjo'
stadorn ns!.s
M.ty:
dd rcDhing vdimr *jth doM3idc rist 6
F,dorirrG Nllrkhr(r@r 20e)
@ndirion
a
n..sur.
ulysn in $G sludy .ncompGs.s nontlly dlL
p'.vios ttldisr h.v. u!.d ir io eli'Llc $.n rcsulls &d to nrtc $n rcs.h
liski
s
lhrcDghoul lhis period . Empnic.l
conp.tibb wnh ih.n. Howfld, ro l.st d* co.dnion of nomliry, rhk sody us.s d.ily
ioFL. v.lu.d ba.d @np.ri.s s diil, &t.xnibit mm
d.pdurc ftom @malily' od s.condly, lh.* top td vale b!.d €npdi.r &cour for
t0% of thc ek l spiElidia. d KSE r
d!1, fron 2005 !o 2010 for
1.5.
StrfttrE ofTl..i8
Th.r
e !t
chrpt 6 ir rhis diss.dion
.xcluding.btui
iclions. Cbvrer I h Inrroduclion to Do*side Rist in
jo@y
of
Eiw
p.rbining to ioDic
as
doMsid.
r.ll
ri*.
h
Ast
di*lsss !in5, limidions
r! diss.rtdion Ch.pl.r Il
is
&
sbdivid.n inro
Prici.g en@npdsing
.nd
6E ohpcr.ncics
Lil.atlr R.vj*
which
t lcs
up
sD€ of disrion dd rplrop.i.cly di$lls tr. Ch.tcr III dats
wilh i$u. of .o6.liry lnd irs D@ti€l si8rifi@cc Coclllid. appr@hes b.s.! on
ar.litio of noorliry dd Elding lhis ondnion e lpplied t.) MzkoPiu podolio rist
.&h
is.
!o
which
undcr
oplim,alion b m..sure outc.he of dcvi.tion tron nomaUiy
Chlplq lV lpDli.s dorDsid. risk lo podfolio 6s.s.m.nt ll
diff.rcM in EsulB
.tici..r iolti.r.
uscs
optiFiz*ion lo a$es
b.rsa v{ie. $d dosid. ;s* a mduEs or ftk
Tlri! rudy ft tunhd *end.d to includc risk-r.ter
irorFtus sLw$
oDd
6ing
icubll inv.nor
mpet
dificMe or podolio @nDo io.
with Esp.ct !o Mv.flam.work. ChlDkr V rppljes do@id. tisk in r$el pricing od
ov.s .DDnial eM of nudy. lt dies*s ln€orshrl r'd cmpi.ic.l ksws in t iing
CAPM rnd DCAPM .nd prcvid.s solurions lor lh.n. TiDc{.ri.s !s N.ll !s dos.nd
.nd kuriosis .nd
IThnrr'F.du:Wivlahieti5H
.ddE$.d ftn nlB du. b n@ lvlillbiriry
;
I
orde .g
^hhrd
rm. d Mr&b ( !9?l) znd FDa ad Fdrh ( r9?)
td etu $e Iis. chd sd xhs ecs4).
sd Qain l20s). rqbrl
d
B@r,
ema
rnt. Thh study asn s rik{r.& inv.srors. noNt|don rd d.cEaing rbsllt isk
ov.nio. (DAM) *h.. il Bls doMrid. ri.k ba.d sset Dricing nodel Hov.rcr, tnis is
i! testi.g rhe nod.l 10 validsl€ ir in .ohptui&n to its 6ut!a.n. ThG
sody lko B.! tudrd risk-nlc Et. rollowi.s Fma ond Maadn 0973) I t.ns
ah.n.tivc ood.lr v6ieq b4cd md doMsid. ist b6c( by buildinS .ftci.nl
frontics for @b 6od.l li !$!h.s lht shon selling tu not allow.d dd dErc is no
s$um.d only
ulinilcd borowi.g sd l.rdir8 lollowin3 Hetow (,991).
Tn. dDincrl mlysk is DriDdily in
rhe
sLsos
i.
lhis snldv: sl!8e
I
dicD$cs
is$s in E$ina bolh dod.k, stg. ll u.rh fo'.sbblhhn.nt
of nsk-Eluh El.rionship. lss6 of nmtlltron ty t r.5 U.obs.bility of tu. ndtcr
.mr, h.!.Ds.d.nicity. lln@ftltrior intdrD.nl hoti?.n td
poffolio, llwl@
.qurucieh'^d pordolios d .ddts.d lr th. ld sriB., l''b Dd dMsid' b'r$
nod.h e. rd.i usiry Fs.-M&Bah (19?r) Dd Ans Cn'n !d Xhs (20s)
nrth.dologi.s. The fom.r G ! @nvmtio l ud srnd.rd p'eduE ro tn ss ptcrl
@ept!.j ud
.mpirieal
bbust6s Alog wilh cb$-sliodl d'lvsi:
ordin ry l4n sq@, (OLs) od gq.t liz.n D.ihod of h@dls (GMM) is used 'n
lin.*ri.s ro t.sl lll. .x?rolive hod.l. How.ta. lhis smdv rcBti's onL'dcd ti6
p'nfolis 6 fom"
on ly .qBl-weignicd portf.lios and do nol fcs on v.lE w.igh'd
rDd.k wnih tn. hrcr
valid.Ls E!uh5
Thc elimarion
sdples
6
i
adoptd for
*id' ob6ln€$ 6 detib.d it
*indo* of inn
b 2010 Dd tlo's nor slriv' tbr tdnSt!
iodd i5 shon 84 lisLdsnpbies in (SE tE lrkd is
sludv is
hisbry of KsE_loO
smpl.. Thn is du. to
rcen lh.r tiis
s
I
For
dlrnb
Fer
rnd M&Edrt
pEvious studicJ
reTr).
fiod
u0o0
Esetrch solecc onlv thoe ooop'ni's which
Fd!.nd r'6ch
ll
(1e92)
!n
r4
clln dn
xnr8 (20'a)
're
lii.d $oudout $n Fiodr. EmDind drtysn in |ItG study .nmnpascs nMtht &h
s pr.vious .rudi€s': hdc uscd it io vllid.tc ih.n resuhs ud lo n *e ihis rcMch
comp.tiblc *nh ln.n. Hoq*.r,lo rn tn. co tition ofnomltity, rhn $dy s.s d.ity
d.r. fton 200s ro 20t0 for top-b v.tud b.s.d 6npsi6 s daity d.r! .xhibn n@
deFtorc non norulity' r.d .endlx th.* lop &D v.tu. bs.d mhpsics ecount rd
50% ofil* mdkel €pirllizlrion oh KSE a
1.5.
Stncturc
fi.E r.
ofTtcli!
di.&rblior .xcludina.bslr&r which e $bdivid.d ido
sdrioB. ch.rb I is Intodetion ro Dosirlc tusk ir As$t Pricing dcohpssirg
jomey of wilM b dosid. nsL I! di$us ritu, tinintiod ud @E @nFcnci6
p.dririnl lo bpic a w.rl6 diesqr.tion. cb.rld rr n LirdoE Rdi4 whi.h rltcs up
ir
5ix chdpleN
rhi5
eah issu. lnds srclc of dhs.fidion dd .pprcpriaLt discu$.s it. Cbrprs III d..h
wilh isss of ronn liry lnd its D@risl sigrifH@. CoftLlior .ppMnc, b$d ot
mtdnion of noorlity ud
oprinalior
cb,tt r Iv
ditr*M
to
ftam
Eldin!
olrc.nc
of
thG @ndition
dcvi*ioi
tln
e
.pplid !o MltowiE Donfolio ris*
non.tjiy.
dolfuiL rirk ro Dortfolio ndas.n.nr. lr u$r orriDizjrio! ro .ss
in Buhr b.tu€n Eiry od dowid. rirk G m6ms or tut using
.pplics
efnci.nt fionds. Thn iudy i! finher
dL.d.i
md ircoDor.t* skcun $
.d 6mpes dif.rcDc?
od tDrbsis
to includ.
n!t{!k r dd
ncurot irvcsltr
ol podolio enDosilion
uth Esp.cr lo Mv-ftm.rorl. Chrp&r v rypliB domsid. n* i. asr ,ricid! 0d
@v6 dpinol *na of rndy. lt dis@. dcotli@t lti .npincd i$kr in rning
CAPM
bd
DCAPM
dd
pevidcs sohtions for lhon.
Tin.€i.s s &ll 6 cru}
I
fin ry FlduE $Rivellir 6is Howv
onPlehin.rydld.tdohp[j6i
t or dd! ..g. ahnd d
hvid sd ahmd (2m& d hb! 4,/ (?0r0).
'FDa dd M&B.rl, oex) rnd Fur -d F'd re).
I
Qdin
(?004), rqb'r
ad B'ook {20o),
FitlE
l
l: SrhcrrE ofrtgi.
t,
sl'oMl ull6is
G
Co@lNior pbviding
enid.
bbs @tr.
|@m.nd.toB for tuM EWIEE
rrpli.d
1.6.
Dirtlbctiv. Fatures
Thn
r!.eh
!o
mdcls !o provid.
Lrn ch.pb
is
h$ file dnihguishiog f€tuEi t.rl.'iniDg 10 til€mrjrc rcvjcw 6d rlldng of
DR-6in.work ud €ndnion of @lity F r,,}] |his tudy mnDes. .xldirc
m..tnlE
di.e ud ecgori4s
rrEpadv.
whjch
ir 6E mjo, siago,i.s: 6r,r
CAPM |nacri..Iy 6 e.lr 6 .optis y. Sao!.|
Drcvious firdinss
aDpl.r.V Ejaa
FBp..ri* rgu.s pne@ ofdonali.s E uhtng in *resion
of sir3t..f.cror
caIM
inb huhi-feior CAPM. Tlird p.np.cd* n hnd of sluijon prcvid., .ddrcsing
tl.or.lical 3hon@nings of CAPM inlo oodi,jcd vcEions or CApM Th. tic,alu.
Evi.* k 6mpr?h.,sir, inlom.ri!. Md !.iq* 6 Donc of
@8on4d lir.nniE Evi.w in dis vry for rh. @ of lh. Eds
prio, nudi.s
hav€
i8lifi6e
of Dom.|ny is n*u.d using flm.r.d (undn a tnion of
mmliry) hd .xc..decc (Etqi.g .onri.ion ot nomlity) oftt.tion mdhodotosi* in
M.rkowiEk poifolio optihi2rioD. Borh ot rh. 6r.ldion F€lhodotogi.s e pEs..l i.
,9&'r'rv.
hlcraluEi how?v.r, rh.y
e
!s.d in MskowiE podotio oprioianion for fiur tim. ro
ase$ din E@ b.iwden tot l, uFi& ud down,idc ,Gk md.. atl.hrtit.j ssumplions.
?7'tdt, rhb snidy nodines Dvo od AEhd (t968) mclhodolo$/ ro d.cmin. th.
toifolio siz du. ro d.t tinidion. Aound .ighry-tor @Dpnics qutit rh. qicri! 5ct
fd
tid.
Ponfolio siz is inportor for sumcj.m nDbcr of
oM.
.sp.ci.lly wh.n cDsssrio',1 mtysis n p.rfom.d. So, lhn sudy EDov6 rh.
short onii! of Ers md Arch.r (1963) ndhodotosy lo drlmine p.nfolio sik. This
modiliotion of Evin snd Arch.r (1968) rcthodotos/ h
d
innov.riv. f.arurc
offiis
aodnl. dowsid. nst
is l€si.d bolh lheoreriely
dd mpincltvr \t.n
icning
ti* tn.octielly, ript.{ort d portrotio,.rc usd to sn od stcrne$.ff.cl
ed .fr*r of hiSh conl.rid b.Nq vdidc. .nd doMsid. nsk Tript.*on d
downsid.
oi st*n.$, vriu@ od dow.sid. rbk .E !!.d ,or ,nn rh. in
building ?ticiot tionli.6 for vlrisc. od doMsid. rit bs.d
fEh.worts.
Addniomllt lh@rclic.t issu.s tit3 bull.rny ctre! odosd.ry and
choq of
Dodolios son€d
artrcpnr. slgorirhDs 4 inpoi.nr in lh. conndcrion of .fiicjcnr 6onti.u.
Th.k
i$u.s a pt@dv.lr.ddBsd io hrt lh. Esuts hoE bbcr
This rechniqe
h.tDs in
cohp&n8 doMsid. nsk
on th.
fid ldiMcc
b$?d iiroewod(
j!
ponfotio mdagem.nr
.epinel
sid., co.vcnlio..t prcc.durc of Frro_MsBd dong vnh
A.g, Cho
ed Xine mdhodoloB, n.nopc.i. Ho*do, pordolio ening b borh
rb. Dd.n@s h
difr.rc.l from origin.t nudi.s An!. Chen od xi.e n.$odolog/
6 adopled lo D.lG rnn
stud, mp.ni.l od $B Fbrsr Thn ody us.s OLs wilh
Nd.y_wcsl ud Whjre
.niDrto6 .nd rcbu$ CMM apporch to c.rq for hd!rcst.ds$rcrry
.nd .urMtr.rction
14rlr lli. rnldy
a'rmnr dri ir is fid of iB tird for KsE_p.tjtu
o
dosnlde
nd
i.
es.t phcrng prev,ous studjcj nov. focu!.d on w
nll fo. KSE-P.tisb ard d|.nd.d lh.n !o inctud. nuni,h.ior od
tl,e
or. of
in
Howcver, rhis stody priDeity focus.s on doqrsidc
lisk
a$l pdcug f@dork for KsE_p.ljrur.
6
@dniodt nod.k
m@uE o, ,isk in a 3inet.