Extracting Tail Risk from High-Frequency S&P 500 Returns

58 Pages Posted: 31 Jul 2018 Last revised: 13 Jan 2020

See all articles by Caio Almeida

Caio Almeida

Princeton University

Kym Ardison

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finanças

René Garcia

Université de Montréal - CIREQ - Département de sciences économiques; University of Montreal

Piotr Orłowski

HEC Montréal

Date Written: January 10, 2020

Abstract

This paper proposes to extract tail risk from a risk-neutral mean-adjusted expected shortfall of high-frequency stock returns. Risk adjustment is based on a nonparametric estimator of the state price density that does not use option prices and relies solely on a stock index returns. This makes the measure methodology applicable to many financial markets with illiquid or nonexistent options. Empirically, the tail risk factor extracted from S\&P 500 returns has a 90% correlation with the options-based VIX index and predicts well realized jumps in the stock market index at various frequencies. We document a persistent negative relation between tail risk and one-day ahead returns of several assets classes. Consistent with the crash-insurance property of put options, tail risk predicts positive one-day ahead returns for portfolios long out-of-the-money, short in-the-money put options. An analysis of equity portfolios sorted on exposure to tail risk reveals a premium for bearing such a risk, even after controlling for known and established factors related to cross-sectional variability. This cross-sectional analysis is robust to the inclusion of uncertainty indexes, as well as macroeconomic and volatility measures.

Suggested Citation

Almeida, Caio and Ardison, Kym and Garcia, René and Orłowski, Piotr, Extracting Tail Risk from High-Frequency S&P 500 Returns (January 10, 2020). Available at SSRN: https://ssrn.com/abstract=3211954 or http://dx.doi.org/10.2139/ssrn.3211954

Caio Almeida (Contact Author)

Princeton University ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States

Kym Ardison

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finanças ( email )

Praia de Botafogo 190/1125, CEP
Rio de Janeiro RJ 22253-900
Brazil

René Garcia

Université de Montréal - CIREQ - Département de sciences économiques ( email )

C.P. 6128, succursale Centre-Ville
3150, rue Jean-Brillant, bureau C-6027
Montreal, Quebec H3C 3J7
Canada
514-985-4014 (Phone)

University of Montreal ( email )

United States

Piotr Orłowski

HEC Montréal ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

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