Application of semi-deviation as a proxy for the expected return estimation in the Croatian equity market

Open access

Abstract

In the field of portfolio management the focus has been on the out-of-sample estimation of the covariance matrix mainly because the estimation of expected return is much more challenging. However, recent research efforts have not only tried to improve the estimation of risk parameters by expanding the analysis beyond the mean-variance setting but also by testing whether risk measures can be used as proxies for the expected return in the stock market. In this research, we test the standard deviation (measure of total volatility) and the semi-deviation (measure of downside risk) as proxies for the expected market return in the illiquid and undeveloped Croatian stock market in the period from January 2005 until November 2017. In such an environment, the application of the proposed methodology yielded poor results, which helps explain the failure of the out-of-sample estimation of the maximum Sharpe ratio portfolio in earlier research in the Croatian equity market.

1. Ang, A., Chen, J., Xing, Y. (2006a). Downside risk. The Review of Financial Studies, Vol. 19, No. 4, pp. 1191-1239.

2. Ang, A., Hodrick, R., Xing, Y., Zhang, X. (2006b). The Cross Section of Volatility and Expected Returns. Journal of Finance, Vol. 51, No. 1, pp. 259-299.

3. Amenc, N., Goltz, F., Martellini, L., Retkowsky, P. (2011). Efficient Indexation: An Alternative to Cap-Weighted Indices. The Journal of Investment Management, Vol. 9, No. 4, pp. 1-23.

4. Amenc, N., Goltz, F., Martellini, L. (2013). Smart Beta 2.0. Nice, France: EDHEC-Risk Institute.

5. Arnerić, J., Jurun, E., Pivac, S. (2006). Parametric Forecasting of Value at Risk Using Heavy Tailed Distribution. In: Proceedings of the 11th International Conference on Operational Research. Pula, pp. 65-75.

6. Arnerić, J., Jurun, E., Pivac, S. (2009). Multivariate risk-return decision making within dynamic estimation. Revista investigación operacional, Vol. 30, No. 1, pp. 11-19.

7. Bali, T. G., Demirtas, K. O., Levy, H. (2009) Is There an Intertemporal Relation between Downside Risk and Expected Returns? Journal of Financial and Quantitative Analysis, Vol. 44, No. 4, pp. 883-909.

8. Benaković, D., Posedel, P. (2010). Do macroeconomic factors matter for stock returns? Evidence from estimating a multifactor model on the Croatian market. Business systems research, Vol. 1, No. 1-2, pp. 1-50.

9. Bollerslev, T., Li, S. Z., Zhao, B. (2018). Good Volatility, Bad Volatility, and the Cross Section of Stock Returns. Journal of Financial and Quantitative Analysis, forthcoming, pp. 1-57.

10. Bollerslev, T., Tauchen, G., Zhou, H. (2009). Expected Stock Returns and Variance Risk Premia. The Review of Financial Studies, Vol. 22, No. 11, pp. 4463-4492.

11. Choueifaty, Y., Coignard, Y. (2008). Toward Maximum Diversification. Journal of Portfolio Management, Vol. 35, No. 1, pp. 40-51.

12. Christoffersen, P., Errunza, V., Jacobs, K., Jin, X. (2012). Is the Potential for International Diversification Disappearing? A Dynamic Copula Approach. Review of Financial Studies, Vol. 25, No. 12, pp. 3711-3751.

13. Dolinar, D. (2013). Test of the Fama-French three-factor model in Croatia. UTMS Journal of Economics, Vol. 4, No. 2, pp. 101-112.

14. Dolinar, D., Orsag, S., Sudar, A. (2014). Macroeconomic factors and stock returns – evidence from Croatian stock market. In: WDSI 2014 proceedings: Western Decision Sciences Institute forty third annual meeting Napa, California: Western Decision Sciences Institute.

15. Dolinar, D., Zoričić, D., Kožul, A. (2017). Towards the Estimation of an Efficient Benchmark Portfolio: The Case of Croatian Emerging Market. Zagreb international review of economics & business, Vol. 20, No. S1, pp. 13-24.

16. Džaja, J., Aljinović, Z. (2013). Testing CAPM model on the emerging markets of the Central and Southeastern Europe. Croatian Operational Research Review (CRORR), Vol. 4, No. 1, pp. 164-175.

17. Fama, E. F., MacBeth, J. D. (1973). Risk, Return, and Equilibrium: Empirical Tests. Journal of Political Economy, Vol. 81, No. 3, pp. 607-636.

18. Fama, E. F., French, K. R. (1993). Common Risk Factors in the Returns on Stocks and Bonds. Journal of Financial Economics, Vol. 33, No. 1, pp. 3-56.

19. Feunou, B., Lopez Aliouchkin, R., Tédongap, R., Xu, L. (2017). Variance Premium, Downside Risk, and Expected Stock Returns. Working paper, pp. 1-50.

20. Fruk, M., Huljak, I. (2004). Testiranje Sharpe-Lintnerova modela na Zagrebačkoj burzi. Financijska teorija i praksa, Vol. 28, No. 1, pp. 77-91.

21. Gardijan, M., Škrinjarić, T. (2015). Estimating investors preferences towards portfolio return distribution in investment funds. CRORR Croatian Operational Research Review, Vol. 6, No. 2, pp. 1-16.

22. Glosten, L. R., Jagannathan, R., Runkle, D. E. (1993). On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks. The Journal of Finance, Vol. 48, No. 5, pp. 1779-1801.

23. Huang, W., Liu, Q., Rhee, S. G., Wu, F. (2012). Extreme downside risk and expected stock returns. Journal of Banking & Finance, Vol. 36, No. 5, pp. 1492-1502.

24. Jurun, E., Pivac, S., Arnerić, J. (2007). Historical and Prognostic Risk Measuring Across Stocks and Markets. Journal of WSEAS Transactions on Business and Economics, Vol. 4, pp. 126-134.

25. Kunovac, D. (2011). Asymmetric correlation on the Croatian equity market. Financial Theory and Practice, Vol. 35, No. 1, pp. 1-24.

26. Ledoit, O., Wolf, M. (2004). Honey, I shrunk the sample covariance matrix. The Journal of Portfolio Management, Vol. 30, No. 4, pp. 110-119.

27. Maillard, S., Roncalli, T., Teiletche, J. (2010). On the Properties of Equally-Weighted Risk Contributions Portfolios. Journal of Portfolio Management, Vol. 36, No. 4, pp. 60-70.

28. Malkiel, B. G., Xu, Y. (1997). Risk and Return Revisited. The Journal of Portfolio Management, Vol. 23, No. 3, pp. 9-14.

29. Martellini, L. (2008). Towards the Design of Better Equity Benchmarks: Rehabilitating the Tangency Portfolio from Modern Portfolio Theory. The Journal of Portfolio Management, Vol. 34, No. 4, pp. 34-41.

30. Minović, J., Živković, B. (2014). CAPM augmented with liquidity and size premium in the Croatian stock market. Ekonomska istraživanja, Vol. 27, No. 1, pp. 191-206.

31. Odobašić, S., Tolušić, M., Tolušić, Z. (2014). The application of CAPM model on selected shares on the Croatian capital market. Ekonomski vjesnik: Review of Contemporary Entrepreneurship, Business, and Economic Issues, Vol. 27, No. 2, pp. 297-311.

32. Perković, A. (2011). Research of beta as adequate risk measure – is beta still alive? Croatian Operational Research Review, Vol. 2, No. 1, pp. 102-111.

33. Škrinjarić, T., Kojić, V. (2014). Modeliranje prinosa dionica na ZSE pomoću Markovljevih lanaca. Ekonomski pregled: Mjesečnik Hrvatskog društva ekonomista Zagreb, Vol. 65, No. 3, pp. 207-221.

34. Škrinjarić, T., Šego, B. (2016). Dynamic portfolio selection on Croatian financial markets: MGARCH approach. Business Systems Research, Vol. 7, No. 2, pp. 78-90.

35. Škrinjarić, T., Šostarić, N. (2014). Komplementarnost metodologije Markovljevih lanaca i Markowitzevog modela optimizacije portfelja. Ekonomska misao i praksa: časopis Sveučilišta u Dubrovniku, Vol. 23, No. 1, pp. 353-370.

36. Verousis, T., Voukelatos, N. (2018). Cross-sectional dispersion and expected returns. Quantitative finance, Vol. 18, No. 5, pp. 813-826.

37. Zoričić, D., Dolinar, D., Lovretin Golubić, Z. (2018a). A test of global minimum variance portfolio in the Croatian capital market. In: Book of proceedings of 7th International Scientific Symposium Economy of Eastern Croatia - Vision and Growth. Osijek: Sveučilište Josipa Jurja Strossmayera u Osijeku, Ekonomski fakultet u Osijeku, pp. 1165-1173.

38. Zoričić, D., Dolinar, D., Lovretin Golubić, Z. (2018b). Performance Analysis of Fundamentally-Weighted Indices in the Croatian Capital Market. Zagreb International Review of Economics & Business, Vol. 21, Special Conference Issue, pp. 43-53.

Journal Information

Metrics

All Time Past Year Past 30 Days
Abstract Views 0 0 0
Full Text Views 45 45 17
PDF Downloads 35 35 14