The impact of downside risk on UK stock returns

Abstract

PurposeThis paper aims to investigate patterns in UK stock returns related to downside risk, with particular focus on stock returns during financial crises.Design/methodology/approachFirst, stocks are sorted into five quintile portfolios based on the relevant beta values (classic beta, downside beta and upside beta, calculated by the moving window approach). Second, patterns of portfolio returns are examined during various sub-periods. Finally, predictive powers of beta and downside beta are examined.FindingsThe downside risk is observed to have a significant positive impact on contemporaneous stock returns and a negative impact on future returns in general. In contrast, an inverse relationship between risk and return is observed when stocks are sorted by beta, contrary to the classic literature. UK stock returns exhibit clear time sensitivity, especially during financial crises.Originality/valueThis paper focuses on the impact of the downside risk on UK stock returns, assessed via a comprehensive sub-period analysis. This paper fills the gap in the existing literature, in which very few studies examine the time sensitivity in relation to the downside risk and the risk-return anomaly in the UK stock market using a long sample period.