K. Ozgur Demirtas

Is There an Intertemporal Relation between Downside Risk and Expected Returns

This paper examines the intertemporal relation between downside risk and expected stock returns. Value at Risk (VaR), expected shortfall, and tail risk are used as measures of downside risk to determine the existence and significance of a risk-return tradeoff. We find a positive and significant relation between downside risk and the portfolio returns on NYSE/AMEX/Nasdaq stocks. VaR remains a superior measure of risk when compared with the traditional risk measures. These results are robust across different stock market indices, different measures of downside risk, loss probability levels, and after controlling for macroeconomic variables and volatility over different holding periods as originally proposed by Harrison and Zhang (1999).

Aggregate Earnings and Expected Stock Returns in Emerging Markets

This paper examines the time-series predictability of aggregate stock returns in twenty emerging markets. In contrast to the aggregate-level findings in the United States, earnings yield forecasts the time series of aggregate stock returns in emerging markets. We consider aggregate earnings not as normalizing variables for stock price but as predictive variables in their own right. Aggregate earnings covary with the market returns; hence, it is not just the mean reversion of stock prices that is responsible for the forecasting power of earnings yield. These results are robust across different estimation methods and after controlling for small-sample bias and macroeconomic variables.

Implied Volatility Spreads and Expected Market Returns

This article investigates the intertemporal relation between volatility spreads and expected returns on the aggregate stock market. We provide evidence for a significantly negative link between volatility spreads and expected returns at the daily and weekly frequencies. We argue that this link is driven by the information flow from option markets to stock markets. The documented relation is significantly stronger for the periods during which (i) SP (ii) cash flow and discount rate news are large in magnitude; and (iii) consumer sentiment index takes extreme values. The intertemporal relation remains strongly negative after controlling for conditional volatility, variance risk premium, and macroeconomic variables. Moreover, a trading strategy based on the intertemporal relation with volatility spreads has higher portfolio returns compared to a passive strategy of investing in the S&P 500 index, after transaction costs are taken into account.

Studies of Equity Returns in Emerging Markets: A Literature Review

We review the literature on empirical asset pricing in emerging markets. This literature is quite diverse and almost thirty years old. To make this task manageable, we focus on equity markets, limit the topics to return predictability and volatility modeling, and restrict the review to the set of top journals in finance and journals that specialize in emerging markets.

Downside Risk in Emerging Markets

This paper investigates the relation between downside risk and expected returns on the aggregate stock market in an international context. Nonparametric and parametric value at risk are used as measures of downside risk to determine the existence of a risk-return trade-off. For emerging markets, fixed effects panel data regressions provide evidence for a significantly positive relationship between monthly expected market returns and downside risk. This result is robust after controlling for aggregate dividend yield and price-to-fundamental ratios. The relationship between expected returns and downside risk is weaker for developed markets and vanishes when control variables are included in the specification.

Testing Mean Reversion in Stock Market Volatility

This paper presents a comprehensive study of continuous time GARCH modeling with the thin-tailed normal and the fat-tailed Student-t and generalized error distributions. The paper measures the degree of mean reversion in stock return volatility based on the relationship between discrete time GARCH and continuous time diffusion models. The convergence results based on the aforementioned distribution functions are shown to have similar implications for testing mean reversion in stochastic volatility. Alternative models are compared in terms of their ability to capture mean-reverting behavior of stock return volatility. The empirical evidence obtained from several stock market indices indicates that the conditional variance, log-variance, and standard deviation of stock market returns are pulled back to some long-run average level over time.

Investing in Stock Market Anomalies

This paper provides an explanation of investing in stock market anomalies in an expected utility paradigm. Classical selection rules fail to provide a preference for high expected return portfolios. The paper utilizes the almost dominance rules to examine the practice of investing in size, book-to-market, momentum, short-term and long-term reversal anomalies. The results indicate that popular investment choices such as value and small stocks do not dominate growth and big stocks. However, the short-term reversal and momentum strategies create efficient investment alternatives. Bilateral comparisons of stock market anomalies provide evidence for the superior performance of size, short-term reversal, and momentum for 1-month to 12-month horizon and book-to-market and long-term reversal for longer term horizons of 3 to 5 years. The relative strength of small, value, momentum-winner, short-term and long-term losers becomes more prevalent when the time-varying conditional distributions are examined.

Macroeconomic Factors and Equity Returns in Borsa Istanbul

This paper investigates equity return exposure to various macroeconomic factors and the performance of factor betas in predicting the cross-sectional variation in stock returns. We utilize a two-step procedure to directly test the implications of the Arbitrage Pricing Theory. First, we calculate monthly factor betas and then, we estimate the sensitivity of equity returns towards the factor betas. We find that (i) there exists a negative and significant relation between interest rate betas and future equity returns; (ii) the inclusion of market, book-to-market, size and momentum factor betas does not subsume the predictive power of the interest rate beta; and (iii) these results are driven by the debt-to-equity ratios of individual firms. We conclude that the financial leverage driven sensitivity of returns towards interest rates is a priced risk factor in the Turkish stock market.

Derivative Markets in Emerging Economies: A Survey

We review the literature on derivatives in emerging markets. This young but booming literature appears to be concentrated on a few countries, but is quite rich in terms of subject coverage. We classify these topics based on the generally recognized functions of derivative markets and restrict the review to the set of top journals in finance and those that specialize on emerging markets or derivatives.

Small Sample Bias in Panel Data

There exists a small sample bias in predictive regressions, when a rate of return is regressed on a lagged stochastic regressor, and the regression disturbance is correlated with the regressors’ innovations. Although this bias can be a serious concern in time-series predictive regressions, it is not significant in panel data setting. By using simulations and stock level data, we document that as the number of cross sections used in the panel data increases the bias in coefficient estimates becomes negligible.