Extreme downside risk and expected stock returns

Wei HUANG, Qianqiu LIU, S. Ghon RHEE, Feng WU*

*Corresponding author for this work

Research output: Journal PublicationsJournal Article (refereed)

43 Citations (Scopus)

Abstract

We propose a measure for extreme downside risk (EDR) to investigate whether bearing such a risk is rewarded by higher expected stock returns. By constructing an EDR proxy with the left tail index in the classical generalized extreme value distribution, we document a significantly positive EDR premium in cross-section of stock returns even after controlling for market, size, value, momentum, and liquidity effects. The EDR premium is more prominent among glamor stocks and when high market returns are expected. High-EDR stocks are generally characterized by high idiosyncratic risk, large downside beta, lower coskewness and cokurtosis, and high bankruptcy risk. The EDR premium persists after these characteristics are controlled for. Although Value at Risk (VaR) plays a significant role in explaining the EDR premium, it cannot completely subsume the EDR effect.

Original languageEnglish
Pages (from-to)1492-1502
Number of pages11
JournalJournal of Banking and Finance
Volume36
Issue number5
DOIs
Publication statusPublished - May 2012
Externally publishedYes

    Fingerprint

Keywords

  • Bankruptcy risk
  • Extreme downside risk
  • Generalized extreme value distribution
  • Idiosyncratic risk

Cite this