Systematic Tail Risk

Maarten van Oordt and Chen Zhou ()

Journal of Financial and Quantitative Analysis, 2016, vol. 51, issue 2, 685-705

Abstract: We test for the presence of a systematic tail risk premium in the cross section of expected returns by applying a measure of the sensitivity of assets to extreme market downturns, the tail beta. Empirically, historical tail betas help predict the future performance of stocks in extreme market downturns. During a market crash, stocks with historically high tail betas suffer losses that are approximately 2 to 3 times larger than their low-tail-beta counterparts. However, we find no evidence of a premium associated with tail betas. The theoretically additive and empirically persistent tail betas can help assess portfolio tail risks.

Date: 2016
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