Safety First, Loss Probability, and the Cross Section of Expected Stock Returns

Ji Cao, Marc Oliver Rieger and Lei Zhao

No 2019-02, Working Paper Series from University of Trier, Research Group Quantitative Finance and Risk Analysis

Abstract: Recent studies show that loss probability (LP) is a decisive factor when peopleevaluate risk of assets in laboratory experiments, suggesting a positive relationshipbetween LP and expected stock returns. This corresponds to the classical “Safety-First” principle. We find strong empirical support for this prediction in the U.S.stock market. During our sample period, average risk-adjusted return differencesbetween stocks in the two extreme LP deciles exceed 0.75% per month. The posi-tive LP effect, characterized by the intention of some investors to pay low prices forhigh LP stocks, remains significant after controlling for traditional downside riskmeasures.

Keywords: Loss Probability; Stock Returns; Mental Accounting; Safety-First; RiskAttitudes (search for similar items in EconPapers)
JEL-codes: G11 G12 G14 (search for similar items in EconPapers)
Pages: 57 pages
Date: 2019
New Economics Papers: this item is included in nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:trr:qfrawp:201902

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