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The cross-section of tail risks in stock returns

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  • Moore, Kyle
  • Sun, Pengfei
  • de Vries, Casper G.
  • Zhou, Chen

Abstract

This paper investigates how the downside tail risk of stock returns is differentiated cross-sectionally. Stock returns follow heavy-tailed distributions with downside tail risk determined by the tail shape and scale. If safety-first investors are concerned with sufficiently large downside losses, i.e. have a sufficiently low risk tolerance, then in the equilibrium, assets traded in the same market share a homogeneous tail shape parameter. Furthermore, if tail shapes are homogeneous, the equilibrium prices of assets are differentiated by the scales.

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File URL: http://mpra.ub.uni-muenchen.de/45592/
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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 45592.

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Date of creation: 19 Feb 2013
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Handle: RePEc:pra:mprapa:45592

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Keywords: Heavy-tail distribution; safety-first utility; asset pricing;

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  1. Loretan, M. & Phillips, P.C.B., 1992. "Testing the Covariance Stationarity of Heavy-Tailed Time Series: An Overview of the Theory with Applications to Several Financial Datasets," Working papers 9208, Wisconsin Madison - Social Systems.
  2. Jondeau, Eric & Rockinger, Michael, 2003. "Testing for differences in the tails of stock-market returns," Journal of Empirical Finance, Elsevier, vol. 10(5), pages 559-581, December.
  3. Arzac, Enrique R. & Bawa, Vijay S., 1977. "Portfolio choice and equilibrium in capital markets with safety-first investors," Journal of Financial Economics, Elsevier, vol. 4(3), pages 277-288, May.
  4. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
  5. repec:dgr:uvatin:2005008 is not listed on IDEAS
  6. Ibragimov, Rustam & Walden, Johan, 2008. "Portfolio diversification under local and moderate deviations from power laws," Insurance: Mathematics and Economics, Elsevier, vol. 42(2), pages 594-599, April.
  7. Hyung, Namwon & de Vries, Casper G., 2007. "Portfolio selection with heavy tails," Journal of Empirical Finance, Elsevier, vol. 14(3), pages 383-400, June.
  8. Namwon Hyung & Casper G. de Vries, 2005. "Portfolio Diversification Effects of Downside Risk," Tinbergen Institute Discussion Papers 05-008/2, Tinbergen Institute.
  9. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2004. "The Cross-Section of Volatility and Expected Returns," NBER Working Papers 10852, National Bureau of Economic Research, Inc.
  10. Zhou, Chen, 2010. "Dependence structure of risk factors and diversification effects," Insurance: Mathematics and Economics, Elsevier, vol. 46(3), pages 531-540, June.
  11. Namwon Hyung, 2005. "Portfolio Diversification Effects of Downside Risk," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 3(1), pages 107-125.
  12. Campbell R. Harvey & Akhtar Siddique, 2000. "Conditional Skewness in Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 55(3), pages 1263-1295, 06.
  13. Hyung, Namwon & de Vries, Casper G., 2012. "Simulating and calibrating diversification against black swans," Journal of Economic Dynamics and Control, Elsevier, vol. 36(8), pages 1162-1175.
  14. Walden, Johan & Ibragimov, Rustam, 2008. "Portfolio Diversification under Local and Moderate Deviations from Power Laws," Scholarly Articles 2640586, Harvard University Department of Economics.
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