Tail Risk and Asset Prices

Bryan Kelly and Hao Jiang

No 19375, NBER Working Papers from National Bureau of Economic Research, Inc

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 across stocks. Our tail measure is significantly correlated with tail risk measures extracted from S&P 500 index options, but is available for a longer sample since it is calculated from equity data. We show that tail risk has strong predictive power for aggregate market returns: A one standard deviation increase in tail risk forecasts an increase in excess market returns of 4.5% over the following year. 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. These findings are consistent with asset pricing theories that relate equity risk premia to rare disasters or other forms of tail risk.

JEL-codes: G01 G12 G13 G17 (search for similar items in EconPapers)
Date: 2013-08
Note: AP
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Citations: View citations in EconPapers (5)

Published as Bryan Kelly & Hao Jiang, 2014. "Tail Risk and Asset Prices," Review of Financial Studies, vol 27(10), pages 2841-2871.

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