The Effect of Left Tail Risk on Expected Excess Returns and Its Consequences on the Persistence of Left Tail Returns

Document Type : Research Paper

Authors

1 Ph.D. Candidate, Department of Accounting, Faculty of Administrate and Economic, University of Isfahan, Iran.

2 Associate Prof., Department of Accounting, Faculty of Administrate and Economic, University of Isfahan, Isfahan, Iran.

3 Assistant Prof., Department of Economic, Faculty of Administrate and Economic, University of Isfahan, Isfahan, Iran.

Abstract

Objective: Left-tailed risk illustrates the probability of unfavorable events that could occur in a range wider than three variances of the distribution function. Although such events have a very low occurrence probability, they would cause significant losses in case of occurrence. This research aims at examining the cross-sectional effects of left-tailed risk on expected excess returns. The present research also examines the probability of the persistence of left-tiled risk in the future.
Methods: In this research two proxies of value at risk and expected shortfall are used to measure left-tailed risk. For this purpose, a sample of 120 companies listed in the Tehran stock market in the period of the years 2010-2017 have been selected. Research hypotheses were examined with the use of Fama and Macbeth regression. Transition matrix was used to determine the probability of left-tailed risk persistence in the future.
Results: According to the findings of the research, left-tailed risk has a significant and negative effect on the expected excess returns. The findings also suggested that the negative returns of the left tail will have a persistence probability of over 50% in the future.
Conclusion: The findings of the present research illustrate a new anomaly in the financial area, which is the negative effect of left-tail risk on the expected excess returns, and persists in the future.

Keywords

References

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Financial Research Journal
Volume 21, Issue 4
2019
Pages 593-611

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