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Systematic Tail Risk

Published online by Cambridge University Press:  10 June 2016

Maarten R. C. van Oordt  and
Chen Zhou
Maarten R. C. van Oordt*
Affiliation:
mvanoordt@bankofcanada.ca, Government of Canada, Bank of Canada, Ottawa, ON K1A 0G9, Canada
Chen Zhou
Affiliation:
c.zhou@dnb.nl, zhou@ese.eur.nl, Economics and Research Division, De Nederlandsche Bank, 1000AB Amsterdam, The Netherlands.
*
*Corresponding author: mvanoordt@bankofcanada.ca
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Abstract

We test for the presence of a systematic tail risk premium in the cross section of expected returns by applying a measure of the sensitivity of assets to extreme market downturns, the tail beta. Empirically, historical tail betas help predict the future performance of stocks in extreme market downturns. During a market crash, stocks with historically high tail betas suffer losses that are approximately 2 to 3 times larger than their low-tail-beta counterparts. However, we find no evidence of a premium associated with tail betas. The theoretically additive and empirically persistent tail betas can help assess portfolio tail risks.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 51 , Issue 2 , April 2016 , pp. 685 - 705
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

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