Revealing Downturns

Martin C Schmalz and Sergey Zhuk

The Review of Financial Studies, 2019, vol. 32, issue 1, 338-373

Abstract: When Bayesian risk-averse investors are uncertain about their assets’ cash flows’ exposure to systematic risk, stock prices react to news more in downturns than in upturns, implying higher volatility in downturns and negatively skewed returns. In good times, less desirable assets with low average cash flows and high market risk perform similar to more desirable assets with high average cash flows and low market risk, rendering them difficult to distinguish. However, their performance diverges in downturns, enabling better inference. Consistent with these predictions, stocks’ reaction to earnings news is up to 70% stronger in downturns than in upturns. Received July 7, 2014; editorial decision March 20, 2018 by Editor Laura Starks. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Date: 2019
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Working Paper: Revealing Downturns (2018)
Working Paper: Revealing Downturns (2018)
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