Expected Shortfall and Value at Risk as Alternative of Market Beta to Explain Cross-Sectional Stock Returns
Expected Shortfall and Value at Risk
Keywords:Risk Management; Expected Shortfall; Value at Risk CAPM; Three-factor model; Five-Factor Model
The objective of this study to risk return model with Value at Risk (VaR) and Expected Shortfall (ES) as the systematic risk factors. Notably, it is tested whether VaR and ES can be used as an alternative of market beta in the traditional Capital Asset Pricing Model (CAPM), three and five-factor model. Data is collected for non-financial companies listed at the Pakistani Stock Exchange. VaR and ES are calculated at two levels of significance, i.e. 95% and 99%. Results showed that the traditional market beta of CAPM, three and five-factor model is not following risk-averse behaviour of investors. Conversely, VaR and ES showed a positive relationship with stock returns supporting the 'high-risk, high return' theory. Furthermore, investment, profitability and size factors become redundant with VaR and ES as systematic risk factors. Therefore, it is recommended that VaR and ES may be used the alternative to market beta to predict the cross sections of stock excess returns.
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