Tail Risk Concerns and International Stock Return Predictability

Abstract

We propose a tail risk concern index using partial least squares based on proxies in the literature and find that it predicts the international stock market return significantly, both in-and out-of-sample, whereas individual proxy has limited predictive power. The tail risk concern index is positively associated with future international economic uncertainty, asymmetrically predicts future macroeconomic conditions, captures two economic channels of tail risk (ex-ante subjective belief and ex-post realizations of tail events), predicts market returns asymmetrically, with stronger power in lowersentiment periods, higher-uncertainty periods, and lower-short interest periods, and predicts market returns via a cash flow channel.

Keywords: Tail risk, International stock markets, PLS, Stock return predictability