Safety First, Loss Probability, and the Cross Section of Expected Stock Returns

58 Pages Posted: 31 Oct 2019

See all articles by Ji CAO

Ji CAO

Yunnan University - School of Development Studies

Marc Oliver Rieger

University of Trier

Lei Zhao

ESCP Business School

Date Written: May 4, 2019

Abstract

Recent studies show that loss probability (LP) is a decisive factor when people evaluate risk of assets in laboratory experiments, suggesting a positive relationship between LP and expected stock returns. This corresponds to the classical "Safety-First" principle. We find empirical support for this prediction in the U.S. stock market. During our sample period, average risk-adjusted return differences between stocks in the two extreme LP deciles exceed 0.73% per month. The positive LP effect, characterized by the intention of some investors to pay low prices for high LP stocks, remains significant after controlling for microcaps as in Hou et al. (2019).

Suggested Citation

CAO, Ji and Rieger, Marc Oliver and Zhao, Lei, Safety First, Loss Probability, and the Cross Section of Expected Stock Returns (May 4, 2019). Proceedings of Paris December 2019 Finance Meeting EUROFIDAI - ESSEC, Available at SSRN: https://ssrn.com/abstract=3478505 or http://dx.doi.org/10.2139/ssrn.3478505

Ji CAO (Contact Author)

Yunnan University - School of Development Studies ( email )

China

Marc Oliver Rieger

University of Trier ( email )

15, Universitaetsring
Trier, 54286
Germany

HOME PAGE: http://www.banking-finance.uni-trier.de

Lei Zhao

ESCP Business School ( email )

79 Avenue de la République
Paris, 75011
France

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