Persistence of jump-induced tail risk and limits to arbitrage. Issue 4 (3rd April 2023)

• Record Type: Journal Article
• Authors: Chow, K. Victor; John, Kose; Li, Jingrui; Sopranzetti, Ben
• Is Part Of: Quantitative finance. Volume 23:Issue 4(2023)
• Page Start: 705
• Page End: 719
• Publication Date: 2023-04-03
• Subjects: Tail risk -- Asymmetry -- Cross-section of stock returns -- Return prediction -- Empirical asset pricing; G11 -- G12 -- G17; Finance -- Periodicals; Business mathematics -- Periodicals; Finance -- Mathematical models -- Periodicals; Investments -- Mathematics -- Periodicals; Economics -- Periodicals; Finances -- Modèles mathématiques -- Périodiques; 332.015118
• DOI: 10.1080/14697688.2022.2151502
• Languages: English
• ISSNs: 1469-7688

Abstract

Abstract : We present a novel methodology to calculate the jump-induced tail risk premium for individual stocks and examine its effect on the following-month's returns. The existence of a premium for bearing negative jump-induced tail risk is significantly associated with negative one-month future returns. In contrast, the existence of a positive premium for bearing jump-induced tail risk has no such significant predictive power. Further, we find that the larger is the magnitude of the premium for negative jump-induced tail risk, the greater and longer-lasting is its impact on expected returns. Lastly, the observed ten-day lag taken to fully incorporate negative jump tail information into price is consistent with limits to arbitrage in the underlying stocks.