Extreme downside risk and expected stock returns

Wei Huang, Qianqiu Liu, S. Ghon Rhee and Feng Wu

Journal of Banking & Finance, 2012, vol. 36, issue 5, 1492-1502

Abstract: We propose a measure for extreme downside risk (EDR) to investigate whether bearing such a risk is rewarded by higher expected stock returns. By constructing an EDR proxy with the left tail index in the classical generalized extreme value distribution, we document a significantly positive EDR premium in cross-section of stock returns even after controlling for market, size, value, momentum, and liquidity effects. The EDR premium is more prominent among glamor stocks and when high market returns are expected. High-EDR stocks are generally characterized by high idiosyncratic risk, large downside beta, lower coskewness and cokurtosis, and high bankruptcy risk. The EDR premium persists after these characteristics are controlled for. Although Value at Risk (VaR) plays a significant role in explaining the EDR premium, it cannot completely subsume the EDR effect.

Keywords: Extreme downside risk; Generalized extreme value distribution; Idiosyncratic risk; Bankruptcy risk (search for similar items in EconPapers)
JEL-codes: G10 G12 G33 (search for similar items in EconPapers)
Date: 2012
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (66)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:36:y:2012:i:5:p:1492-1502

DOI: 10.1016/j.jbankfin.2011.12.014

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