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Underestimating Left-tail Persistence Among Individual Stocks?

Posted in Equity Premium, Momentum Investing

Do investors underestimate the adverse import of large left tails for future stock returns? In their November 2017 paper entitled "Left-Tail Momentum: Limited Attention of Individual Investors and Expected Equity Returns", Yigit Atilgan, Turan Bali, Ozgur Demirtas and Doruk Gunaydin investigate the relationship between left-tail risk and next-month returns for U.S. and international stocks. They measure left-tail risk at the end of each month via either of:

  • Value-at-risk (VaR) - daily return of a stock at the first (VAR1) or fifth (VAR5) percentile of its returns over the past one year (250 trading days).
  • Expected shortfall - average daily return of a stock for the bottom 1% (ES1) or bottom 5% (ES5) of its returns over the past year (250 trading days).

They then sort stocks into tenths (deciles) based on left-tail risk and examine variation in next-month average gross returns across deciles. Using daily prices and monthly firm characteristics and risk factors for U.S. stocks with month-end prices at least $5 during January 1962 through December 2014, they find that:

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