Underestimating Left-tail Persistence Among Individual Stocks?

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: (more…)