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Tail risk and expected stock returns around the world

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  • Long, Huaigang
  • Zhu, Yanjian
  • Chen, Lifang
  • Jiang, Yuexiang

Abstract

In this study, we construct three proxies for tail risk observed in 39 markets between 1980 and 2015 to examine its effects on global pricing: TRKJ, following Kelly and Jiang (2014), TRVZ, following Van Oordt and Zhou (2016), and TRHL, following Huang et al. (2012) and Long et al. (2018). Both the portfolio analyses and Fama-MacBeth regressions show that TRKJ has no pricing effect in the international markets, but both TRVZ and TRHL has a negative relationship with future stock returns, especially in developed markets, which is inconsistent with common sense assumptions regarding the risk-return tradeoff. This negative relationship can be explained by the “idiosyncratic volatility puzzle” in the international markets other than the U.S. market. Moreover, a detailed analysis of the U.S. market suggests that the negative tail-risk–stock returns relationship in that market cannot be explained by the momentum effect, skewness, heterogeneous beliefs, the liquidity factor, leverage, or profitability, leaving an unsolved puzzle, which we call the “tail risk puzzle”

Suggested Citation

  • Long, Huaigang & Zhu, Yanjian & Chen, Lifang & Jiang, Yuexiang, 2019. "Tail risk and expected stock returns around the world," Pacific-Basin Finance Journal, Elsevier, vol. 56(C), pages 162-178.
    • Handle: RePEc:eee:pacfin:v:56:y:2019:i:c:p:162-178
    DOI: 10.1016/j.pacfin.2019.06.001
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    Cited by:

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    2. Ahamuefula E. Ogbonna & Olusanya E. Olubusoye, 2021. "Tail Risks and Stock Return Predictability - Evidence From Asia-Pacific," Asian Economics Letters, Asia-Pacific Applied Economics Association, vol. 2(3), pages 1-6.
    3. Salisu, Afees A. & Adediran, Idris & Omoke, Philip C. & Tchankam, Jean Paul, 2023. "Gold and tail risks," Resources Policy, Elsevier, vol. 80(C).
    4. Yang, Liuyong & Long, Yijia & Long, Huaigang & Zaremba, Adam & Zhou, Wenyu, 2022. "Is tail risk priced in the cross-section of Chinese mutual fund returns?," Finance Research Letters, Elsevier, vol. 50(C).
    5. Tan, Zhengxun & Xiao, Binuo & Huang, Yilong & Zhou, Li, 2021. "Value at risk and return in Chinese and the US stock markets: Double long memory and fractional cointegration," The North American Journal of Economics and Finance, Elsevier, vol. 56(C).

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    More about this item

    Keywords

    Tail risk; International markets; Return predictability; Tail risk puzzle; Idiosyncratic volatility;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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