Tail Risk in the Cross Section of Alternative Risk Premium Strategies

Abstract

In this article, the authors attempt to get a better understanding of the cross-section of alternative risk premiums using a multi-asset version of the downside risk capital asset pricing model (CAPM). In line with the empirical literature, they find that the cross-section of realized returns is much better explained when using the downside CAPM, rather than relying on the traditional CAPM. However, in contrast to the empirical literature, the authors cannot always recover the required signs in their cross-sectional regressions. In particular, they find that taking on downside risk is not always systematically rewarded. This might be due to the limited availability of time series that essentially overweight the exceptional events of 2008 or a direct result of creating backtests with attractive in-sample features that are impossible to repeat out-of-sample.