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 show how to estimate the threshold which identifies
the 'disappointment' event triggering the bad state of the world; we permit
different factor structures for asset returns in good and bad states; we show
how to recover the observable factors' risk premia from the estimated latent
ones in different states. The usefulness of the model is illustrated through two
applications to cross-sections of asset returns in equity markets and other
major asset classes.
Paper link
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3937321
22 Aprile 2022
Lorenzo Trapani
University of Nottingham