The authors examine how extreme stock price declines reveal changing crash risk and its relationship with expected returns. Their findings suggest investors demand greater compensation when tail risk rises, while stocks more exposed to that risk earn higher historical returns and economic activity weakens.
Tail Risk and Asset Prices
Hao Jiang, Bryan Kelly
Research
55 Pages
Key Takeaways
Tail Risk Premium: Stocks with the highest tail risk exposure earned annual returns adjusted for market, size, and value factors 5.4 percentage points above the lowest exposure group.
Return Forecasting Power: Tail risk achieved a 4.5% forecasting R² for annual market returns outside the estimation sample, compared with 6.1% within it.
Fundamental Risk Connection: Tail risk in stock returns had a 31% correlation with tail risk in company sales growth, connecting market extremes to business fundamentals.
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