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Safety first, loss probability, and the cross section of expected stock returns

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  • Cao, Ji
  • Rieger, Marc Oliver
  • Zhao, Lei

Abstract

Recent studies show that loss probability (LP) is a decisive factor when people evaluate assets in laboratory experiments, suggesting a positive relationship between LP and expected stock returns. This corresponds to the classical “Safety-First” principle. We find strong empirical support for this prediction in the U.S. stock market. During our sample period, average risk-adjusted return differences between stocks in the two extreme LP deciles exceed 0.57% per month. The positive LP effect, characterized by the intention of some investors to pay low prices for high LP stocks, remains significant after controlling for traditional downside risk measures.

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  • Cao, Ji & Rieger, Marc Oliver & Zhao, Lei, 2023. "Safety first, loss probability, and the cross section of expected stock returns," Journal of Economic Behavior & Organization, Elsevier, vol. 211(C), pages 345-369.
    • Handle: RePEc:eee:jeborg:v:211:y:2023:i:c:p:345-369
    DOI: 10.1016/j.jebo.2023.04.022
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    More about this item

    Keywords

    Loss probability; Mental accounting; Risk attitudes; Safety-First; Stock returns;
    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
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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