Study On The Relationship Between Left Tail Risk And Future Returns Of Individual Stocks

Tail risk refers to the risk of large changes in market prices in a short period of time,including price booms and busts,resulting in extreme profits or losses greater than a certain standard deviation of the mean distribution of asset returns.This paper focuses on the left-tail risk,that is,the extreme loss part of the income distribution.It is a risk with low probability of occurrence,but once it occurs,it will bring huge losses.The relationship between risk and asset return has always been one of the classic questions in financial research.In general,it is believed that there is a positive relationship between risk and return,and risk-averse investors require higher expected income when holding financial assets with higher risks.However,Atilgan et al.(2020)found that there was a significant negative cross-sectional relationship between left-tail risk and future returns in the American stock market,and believed that this was caused by investors’ insufficient response and underestimating the persistence of left-tail risk.When low returns continue into the future,left-tail risk anomalies would appear.Therefore,this paper studies the existence and causes of left-tail risk anomaly in Chinese stock market.This paper firstly summarizes the literature on tail risk and asset pricing and then analyzes the existence and reason of left-tail risk anomaly in Chinese stock market theoretically.Furthermore,this paper uses univariate combination analysis method,bivariate combination analysis method and Fama-Macbeth cross section regression analysis method to carry out empirical analysis based on the stock data of Chinese A-share listed companies from 2002 to 2021.The results show that there is an anomaly of left-tail risk in Chinese stock market,and there is a significant negative correlation between left-tail risk of individual stocks and future returns.Moreover,the abnormal results can not be explained by common corporate characteristic variables.In terms of explanation and analysis,firstly,investors’insufficient response is one of the reasons for the occurrence of the anomaly.Investors underestimate the persistence of left-tail risk,respond inadequately to high left-tail risk,and the loss will continue into the future.Second,investors’ heterogeneous beliefs aggravate the formation of left-tail risk anomaly,and different investors hold different views on stocks with high left-tail risk.Due to arbitrage costs and other factors,pessimistic views are not easy to show,while optimistic views are easier to reflect.As a result,the current price of stocks with high left-tail risk is overvalued,showing more obvious left-tail anomaly.Third,the left-tail risk anomaly is more obvious in the stocks with strong short-selling restrictions.Due to the short-selling restrictions on the non-margin stocks with high left-tail risk,it is difficult for investors to express pessimistic views through short selling.Negative information is more slowly reflected in the stock price,and the left-tail risk anomaly is more obvious.Based on the results of theoretical and empirical research,this paper puts forward suggestions for investors,listed enterprises and Chinese capital market regulatory authorities respectively.It holds that Chinese investors should attach importance to left-tail risk,recognize its continuity,stop losses in time,and enhance their own information collection and processing ability,while listed companies need to further strengthen information disclosure and risk management.For Chinese market regulatory authorities,We can pay more attention to and prevent left tail risk and perfect short selling mechanism.