Essays on asset pricing and downside risk

This dissertation presents three essays on asset pricing and downside risk. The first chapter investigates whether the variation in asset returns can be captured by the association of returns with the conditional risk premia. I propose asset pricing models that distinguish market factor between upside and downside components. The central idea of these models is that investors care differently between downside losses and upside gains, and asset pricing models that distinguish downward market from upward trend appear to characterize investors' risk perception. The finding of the study shows that downside risk is an informative measure of risk, and asset pricing models that characterize the disappointment aversion of representative investors better explains the variation of equities, currencies, bonds, commodities and CDS returns. The second chapter provides an empirical investigation of momentum in equity and currency markets. Momentum strategy offers higher Sharpe ratio than the market return. However, it exposes to huge crash risk following market rebound. I propose optimal risk management strategy to mitigate momentum crash based on hedging the time-varying risk exposure of momentum then scaling the hedged long- short portfolio by its forecasted semi-variance. This strategy remarkably mitigates momentum crash and provides higher positive returns in the crisis and tranquil periods. Looking at currency markets, huge crash risk is not prevalent in currency momentum. Idiosyncratic risk accounts for the main source of currency momentum risk. The third chapter examines the existence of idiosyncratic risk premia in stock markets. The relationship between idiosyncratic risk and stock returns is subject to idiosyncratic risk measures. Average stock returns increase monotonically with the increase in the conditional idiosyncratic volatility. However, when one-month lagged idiosyncratic volatility used as a proxy of specific risk, a systematic pattern is not found. The conditional idiosyncratic volatility priced positively in a downside market. The overall result demonstrates that investors require a positive risk premium to hold stocks with high idiosyncratic risk.