In
investing,
upside risk is the uncertain possibility of gain. It is measured by
upside beta. An alternative measure of upside risk is the upper semi-deviation. Upside risk is calculated using data only from days when the benchmark (for example S&P 500 Index) has gone up.
[1] Upside risk focuses on uncertain positive returns rather than negative returns. For this reason, upside risk is not a “
risk” at all in the sense of a possibility of adverse outcomes. It is actually beneficial to investors, because it represents the element of
beta that investors profit from. Therefore, higher upside risk is better than lower, and upside risk is preferable to
downside risk.
“One can have a situation where an asset with tremendous upside movement and little downside movement would appear to be riskier than another asset with moderate upside or downside movement.”
[3] In other words, a stock with a high
upside beta might generate the illusion of
risk. For example, one can consider stocks A and B, which have the same
downside risk. However, stock A’s upside beta is larger than the upside beta of stock B. Stock A’s
CAPM beta will be larger than that of stock B, and thus stock A might be viewed by some investors as being more risky. In reality, stocks A and B have the same level of risk because they both have same downside risks, and stock A would actually be a more profitable stock to invest in. An investor who looked at the upside and downside risks of these two stocks separately would see this distinction, and be able to make the more logical investing decision, whereas an investor who relied only upon the CAPM beta would not.
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