Volatility vs. Tail Risk: Which One is Compensated in Equity Funds?
James X. Xiong
Ibbotson Associates, a Morningstar company
Ibbotson Associates - A Morningstar Company
Roger G. Ibbotson
Yale School of Management; Zebra Capital Management, LLC
May 30, 2013
Journal of Portfolio Management, Forthcoming
Research that has led to what is known as the “low volatility anomaly” in cross-sectional stocks from a similar universe indicates that volatility is not compensated with a “volatility” premium. We find evidence of a risk premium, but it depends on the definition or measure of risk. “Tail risk” measures the probability of having significant losses and should be what investors care about the most. We investigated several risk measures, including volatility and tail risk, and found that volatility is not compensated but tail risk is compensated with higher expected return in both U.S. and non-U.S. equity funds.
Keywords: Volatility, Tail Risk, Equity funds
JEL Classification: G11, G12, G23
Date posted: June 5, 2013