Retail investors and overpricing of left-tail risk: evidence from the Korean stock market

- The authors examined whether stocks with higher left-tail risk measures earn higher or lower futures returns. Specifically, the authors estimate the cross-sectional principal component of a battery of left-tail risk measures and analyze future returns on stocks with high principal component values. In contrast to finance theories on the risk–return trade-off relationship, the study results show that high left-tail risk stocks have lower future returns. This finding is robust to various left-tail risk measures and controls for other risk factors. Moreover, the negative relationship between the left-tail risk and returns is more pronounced for stocks that are actively traded by retail investors. This empirical result is consistent with behavioral theory that when investors make decisions based on experience, they tend to underweight the likelihood of rare events.