Extreme downside risk and expected stock returns

Wei Huang, Qianqiu Liu, Sangghon Rhee, Feng Wu

Research output: Contribution to journalArticleResearchpeer-review

61 Citations (Scopus)


We propose a measure for extreme downside risk (EDR) to investigate whether bearing such a risk is rewarded by higher expected stock returns. By constructing an EDR proxy with the left tail index in the classical generalized extreme value distribution, we document a significantly positive EDR premium in cross-section of stock returns even after controlling for market, size, value, momentum, and liquidity effects. The EDR premium is more prominent among glamor stocks and when high market returns are expected. High-EDR stocks are generally characterized by high idiosyncratic risk, large downside beta, lower coskewness and cokurtosis, and high bankruptcy risk. The EDR premium persists after these characteristics are controlled for. Although Value at Risk (VaR) plays a significant role in explaining the EDR premium, it cannot completely subsume the EDR effect.
Original languageEnglish
Pages (from-to)1492 - 1502
Number of pages11
JournalJournal of Banking and Finance
Issue number5
Publication statusPublished - 2012
Externally publishedYes

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