TY - JOUR
T1 - Persistence of jump-induced tail risk and limits to arbitrage
AU - Chow, K. Victor
AU - John, Kose
AU - Li, Jingrui
AU - Sopranzetti, Ben
N1 - Publisher Copyright:
© 2022 Informa UK Limited, trading as Taylor & Francis Group.
PY - 2023
Y1 - 2023
N2 - 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.
AB - 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.
KW - Asymmetry
KW - Cross-section of stock returns
KW - Empirical asset pricing
KW - Return prediction
KW - Tail risk
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U2 - 10.1080/14697688.2022.2151502
DO - 10.1080/14697688.2022.2151502
M3 - Article
AN - SCOPUS:85143406574
SN - 1469-7688
VL - 23
SP - 705
EP - 719
JO - Quantitative Finance
JF - Quantitative Finance
IS - 4
ER -