Conditional extreme risk, black swan hedging, and asset prices

S. Ghon Rhee and Wu, Feng (Harry)

Journal of Empirical Finance, 2020, vol. 58, issue C, 412-435

Abstract: Motivated by the asset pricing theory with safety-first preference, we introduce and operationalize a conditional extreme risk (CER) measure to describe expected stock performance conditional on a small-probability market downturn (black swan). We document a significant CER premium in the cross-section of expected returns. We also demonstrate that CER explains the premia to downside beta, coskewness, and cokurtosis. CER provides distinct information regarding black swan hedging that cannot be captured by co-crash-based tail dependence measures. As we find that the pricing effect is stronger among black swan hedging stocks, this distinction helps explain the absence of premium to tail dependence.

Keywords: Conditional extreme risk; Black swan hedging; Safety-first; Extreme value theory; Asset pricing (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:58:y:2020:i:c:p:412-435

DOI: 10.1016/j.jempfin.2020.07.002

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