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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/31271
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| Title: | Hybrid Tail Risk and Expected Stock Returns: When Does the Tail Wag the Dog? |
| Authors: | Whitelaw, Robert F.
Bali, Turan G.
Cakici, Nusret |
| Issue Date: | 7-Oct-2011 |
| Series/Report no.: | FIN-11-007 |
| Abstract: | This paper introduces a new, hybrid measure of covariance risk in the
lower tail of the stock return distribution, motivated by the
under-diversified portfolio holdings of individual investors, and
investigates its performance in predicting the cross-sectional variation
in stock returns over the sample period July 1963-December 2009. Our key
innovation is that the covariance is measured across the states of the
world in which the individual stock return is in its left tail, not
across the corresponding tail states for the market return as in
standard systematic risk measures. The results indicate a positive and
significant relation between what we label hybrid tail covariance risk
(H-TCR) and expected stock returns, in contrast to the insignificant or
negative results for purely stock-specific or standard systematic tail
risk measures. A trading strategy that goes long stocks in the highest
H-TCR decile and shorts stocks in the lowest H-TCR decile produces
average raw and risk-adjusted returns of 6% to 8% per annum, consistent
with results from a cross-sectional regression analysis that controls
for a battery of known predictors. |
| URI: | http://hdl.handle.net/2451/31271 |
| Appears in Collections: | Finance Working Papers
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