Tail Risk and Asset Prices in the Short-term
51 Pages Posted: 23 Sep 2022 Last revised: 2 Dec 2023
Date Written: December 1, 2023
We combine high-frequency stock returns with risk-neutralization to extract the daily common component of tail risks perceived by investors in the cross-section of firms. Our tail risk measure significantly predicts the equity premium and variance risk premium at short-horizons. Furthermore, a long-short portfolio built by sorting stocks on their recent exposure to tail risk generates abnormal returns with respect to standard factor models. Incorporating investors' preferences via risk neutralization is fundamental to our findings: the predictive power of the physical tail risk is weaker and generally subsumed by its risk-neutral counterpart.
Keywords: Left tail risk, return predictability, factor models, risk-neutralization, high-frequency data
JEL Classification: C58, G12, G17
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