Title: Factor models with downside risk
Authors: Daniele Massacci - Kings College London (United Kingdom) [presenting]
Lucio Sarno - University of Cambridge (United Kingdom)
Lorenzo Trapani - Cass Business School (United Kingdom)
Abstract: We propose a conditional model of asset returns in the presence of common factors and downside risk. Specifically, we generalize existing latent factor models in three ways: we allow for downside risk via a threshold specification which allows for the estimation of the (usually set a priori) 'disappointment event'; we permit different factor structures (and number of factors) in different regimes; we show how to recover the observable factors risk premia from the estimated latent ones in different regimes. The usefulness of this generalized model is illustrated through three applications to low-dimensional, medium-sized, and large cross-sections of asset returns.