Tail Risk and Asset Prices

51 Pages Posted: 30 Aug 2013

See all articles by Bryan T. Kelly

Bryan T. Kelly

Yale SOM; AQR Capital Management, LLC; National Bureau of Economic Research (NBER)

Hao Jiang

Michigan State University

Multiple version iconThere are 2 versions of this paper

Date Written: August 2013

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 across stocks. Our tail measure is significantly correlated with tail risk measures extracted from S&P 500 index options, but is available for a longer sample since it is calculated from equity data. We show that tail risk has strong predictive power for aggregate market returns: A one standard deviation increase in tail risk forecasts an increase in excess market returns of 4.5% over the following year. 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. These findings are consistent with asset pricing theories that relate equity risk premia to rare disasters or other forms of tail risk.

Suggested Citation

Kelly, Bryan T. and Jiang, Hao, Tail Risk and Asset Prices (August 2013). NBER Working Paper No. w19375. Available at SSRN: https://ssrn.com/abstract=2318278

Bryan T. Kelly (Contact Author)

Yale SOM ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Hao Jiang

Michigan State University ( email )

315 Eppley Center
Department of Finance
East Lansing, MI 48824
United States

HOME PAGE: http://sites.google.com/site/haojiangfinance/

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