Editor's Choice Tail Risk and Asset Prices

Bryan Kelly and Hao Jiang

The Review of Financial Studies, 2014, vol. 27, issue 10, 2841-2871

Abstract: We propose a new measure of time-varying tail risk that is directly estimable from the cross-section of returns. We exploit firm-level price crashes every month to identify common fluctuations in tail risk among individual stocks. Our tail measure is significantly correlated with tail risk measures extracted from S&P 500 index options and negatively predicts real economic activity. We show that tail risk has strong predictive power for aggregate market returns. Cross-sectionally, stocks with high loadings on past tail risk earn an annual three-factor alpha 5.4% higher than stocks with low tail risk loadings. We explore potential mechanisms giving rise to these asset pricing facts.

Date: 2014
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The Review of Financial Studies is currently edited by Itay Goldstein

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