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Jump tail risk exposure and the cross-section of stock returns

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  • Alexiou, Lykourgos
  • Rompolis, Leonidas S.

Abstract

We introduce a new jump tail risk measure retrieved from option prices. We examine the cross-sectional pricing of stocks according to their sensitivities to jump tail risk. We find a negative market price of jump tail risk. A high-low portfolio sorted by jump tail risk betas delivers a statistically and economically significant negative premium of -9.95% per year. Risk-adjusted returns are also negative and highly significant. We document that the negative jump tail risk premium is mainly driven by its downside jump tail risk component. On the contrary, the premium of the high-low portfolio sorted by upside jump tail risk betas is insignificant. The negative premium of downside jump tail risk is significant when controlling for various risk factor loadings and firm characteristics, and remains strong for large firms. Our results carry over to a predictive setting, in which we compare subsequent realized returns of the quintile portfolios sorted by downside jump tail risk betas estimated over the previous period.

Suggested Citation

  • Alexiou, Lykourgos & Rompolis, Leonidas S., 2024. "Jump tail risk exposure and the cross-section of stock returns," Journal of Empirical Finance, Elsevier, vol. 79(C).
    • Handle: RePEc:eee:empfin:v:79:y:2024:i:c:s0927539824000999
    DOI: 10.1016/j.jempfin.2024.101565
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    More about this item

    Keywords

    Jump tail risk; Option prices; Stock returns; Factor models;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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