Left-tail momentum: Underreaction to bad news,costly arbitrage and equity returns |
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| Institution: | 1. Sabanci University, School of Management, Orhanli Tuzla 34956, Istanbul, Turkey;2. Georgetown University, McDonough School of Business, Washington, D.C. 20057, USA;1. University of Colorado, United States;2. University of Michigan, United States;3. Federal Reserve Bank of Chicago, United States;4. NBER, United States;1. Federal Home Loan Bank of Des Moines, 909 Locust St, Des Moines, IA 50309, United States;2. C.T. Bauer College of Business, University of Houston, 4750 Calhoun Rd, Houston, TX 77004, United States;1. Lee Kong Chian School of Business, Singapore Management University, 50 Stamford Road, 178899, Singapore;2. School of Economics, Singapore Management University, 90 Stamford Road, 178903, Singapore;3. Olin School of Business, Washington University in St. Louis, 1 Brookings Drive, St. Louis, MO 63130, USA;4. China Academy of Financial Research (CAFR), 211 West Huaihai Road, Shanghai 200030, China |
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| Abstract: | This paper documents a significantly negative cross-sectional relation between left-tail risk and future returns on individual stocks trading in the US and international countries. We provide a behavioral explanation to this anomaly based on the idea that investors underestimate the persistence in left-tail risk and overprice stocks with large recent losses. Thus, low returns in the left-tail of the distribution persist into the future causing left-tail return momentum. We find that the left-tail risk anomaly is stronger for stocks that are more likely to be held by retail investors, that receive less investor attention, and that are costlier to arbitrage. |
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