An Analytical Framework for Explaining Relative Performance of CAPM Beta and Downside Beta
International Journal of Theoretical and Applied Finance, Vol. 12, No. 3, pp. 341-358, 2009
Posted: 2 Dec 2009
Abstract
Even though investors' view of risk is generally regarded as related to the downside of the return distribution the CAPM beta is still a widely used measure of systematic risk. A number of studies compare the empirical performance of CAPM beta and downside beta in explaining the variation in portfolio returns and report mixed results. This paper provides a basis for explaining such mixed results. Using data generating processes in the mean-variance and mean-lower partial moment frameworks, analytical relationships between the CAPM beta and downside beta are derived. The derived relationships reveal that the association between the two systematic risk measures is to a great extent dependent on the volatility of the market portfolio returns and the deviation of the target rate from the risk-free rate. How the relationships derived here may be used in practice is demonstrated using empirical data.
Keywords: CAPM beta, downside beta, equilibrium pricing models, data generating processes, asset pricing
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