Aggregate Tail Risk and Expected Returns

40 Pages Posted: 14 Nov 2014 Last revised: 23 Jun 2016

See all articles by David A. Chapman

David A. Chapman

McIntire School, University of Virginia

Michael F. Gallmeyer

University of Virginia (UVA) - McIntire School of Commerce

Date Written: June 16, 2016

Abstract

We examine the connection between tail risk — as measured in Kelly and Jiang (2014) — and the cross-section of expected returns. In conditional predictive regression systems and vector-autoregressions of the market portfolio and the long- and shoresides of the Fama-French factor portfolios, the tail measure has very weak marginal explanatory power. If anything, tail risk appears to forecast discount rates — and not cash flows — which seems inconsistent with crash-based explanations of the importance of tail risk. We also compare the time series of tail risk to measures of aggregate uncertainty, a measure of funding risk, and three Treasury term structure factors. Tail risk Granger causes and is Granger caused by the level of the term structure, and the slope of the term structure Granger causes tail risk.

Keywords: tail risk, disaster risk, expected returns

JEL Classification: G12

Suggested Citation

Chapman, David A. and Gallmeyer, Michael F., Aggregate Tail Risk and Expected Returns (June 16, 2016). Available at SSRN: https://ssrn.com/abstract=2523018 or http://dx.doi.org/10.2139/ssrn.2523018

David A. Chapman (Contact Author)

McIntire School, University of Virginia ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States

HOME PAGE: http://https://sites.google.com/site/davidchapmanswebsite/

Michael F. Gallmeyer

University of Virginia (UVA) - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States
434-243-4043 (Phone)
434-924-7074 (Fax)

HOME PAGE: http://www.commerce.virginia.edu/faculty_research/facultydirectory/Pages/Gallmeyer.aspx

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