Macro Tail Risk and Market Risk Premium

50 Pages Posted: 13 Sep 2022 Last revised: 7 Oct 2023

See all articles by Jian Chen

Jian Chen

Xiamen University - School of Economics

Cunfei Liao

Nanjing University of Science and Technology - School of Economics and Management

Guohao Tang

Hunan University - College of Finance and Statistics

Date Written: September 1, 2022

Abstract

This study proposes a new index of aggregate macro tail risk based on the forecasts of future macroeconomic fundamentals. Using this index, we find that a positive market risk premium compensates for the economic tail risk; a high tail risk predicts a subsequent high return. This predictability exists both in- and out-of-sample, and cannot be explained by extant stock tail risk and economic uncertainty measures. We exploit the underlying economic mechanism and demonstrate that macro tail risk contains information about the future economic conditions and influences stock returns primarily through both cash flow and discount rate channels.

Keywords: Macro Tail Risk, Return Predictability, Out-of-sample, Partial Least Squares (PLS)

JEL Classification: C22, C53, G12, G17

Suggested Citation

Chen, Jian and Liao, Cunfei and Tang, Guohao, Macro Tail Risk and Market Risk Premium (September 1, 2022). Available at SSRN: https://ssrn.com/abstract=4209339 or http://dx.doi.org/10.2139/ssrn.4209339

Jian Chen

Xiamen University - School of Economics ( email )

422 Siming Nan Road
Xiamen, Fujian 361005
China

Cunfei Liao

Nanjing University of Science and Technology - School of Economics and Management ( email )

No.200 Xiao Lingwei Street
Nanjing, Jiangsu 210094
China

Guohao Tang (Contact Author)

Hunan University - College of Finance and Statistics ( email )

Lushan Road (S), Yuelu District
Changsha, Hunan 410006
China

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