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Editor's Choice Tail Risk and Asset Prices

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  • Bryan Kelly
  • Hao Jiang

Abstract

We propose a new measure of time-varying tail risk that is directly estimable from the cross-section of returns. We exploit firm-level price crashes every month to identify common fluctuations in tail risk among individual stocks. Our tail measure is significantly correlated with tail risk measures extracted from S&P 500 index options and negatively predicts real economic activity. We show that tail risk has strong predictive power for aggregate market returns. Cross-sectionally, stocks with high loadings on past tail risk earn an annual three-factor alpha 5.4% higher than stocks with low tail risk loadings. We explore potential mechanisms giving rise to these asset pricing facts.

Suggested Citation

  • Bryan Kelly & Hao Jiang, 2014. "Editor's Choice Tail Risk and Asset Prices," The Review of Financial Studies, Society for Financial Studies, vol. 27(10), pages 2841-2871.
    • Handle: RePEc:oup:rfinst:v:27:y:2014:i:10:p:2841-2871.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhu039
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