Market demand shocks, bottom-up approach to firm’s risk analysis, and risk-return arbitrages

In recent decades, firms have increasingly faced shocks in demand caused by factors both endogenous and exogenous to the economic system. Indeed, in several industries, mainly in those characterized by strong interconnections with other industries and with the dynamics of macroeconomic variables, firms are increasingly subject to extraordinary positive and negative change in demand for their goods. In this vein, the risk-return profile of individual firms tends to alternate optimal conditions with suboptimal ones. The present paper aims to develop a theoretical framework focused on the opportunity to exploit positive and negative shocks in demand to take advantages in terms of risk-return arbitrages. To this end, our analysis emphasizes the role of unlevered risk (or operating risk) decomposition according to a managerial logic. This implies a risk-return modelling partially in contrast with traditional risk-return models coming from canonical financial theory.