Safety First, Loss Probability, and the Cross Section of Expected Stock Returns

Author: Ji Cao, Marc Oliver Rieger, Lei Zhao

Recent studies show that loss probability (LP) is a decisive factor when people evaluate risk of assets in laboratory experiments, suggesting a positive relationship between LP and expected stock returns. This corresponds to the classical "Safety-First" principle. We find empirical support for this prediction in the U.S. stock market. During our sample period, average risk-adjusted return differences between stocks in the two extreme LP deciles exceed 0.73% per month. The positive LP effect, characterized by the intention of some investors to pay low prices for high LP stocks, remains significant after controlling for microcaps as in Hou et al. (2019).



CAO, Ji and Rieger, Marc Oliver and Zhao, Lei, Safety First, Loss Probability, and the Cross Section of Expected Stock Returns (May 4, 2019). Proceedings of Paris December 2019 Finance Meeting EUROFIDAI - ESSEC, Available at SSRN: https://ssrn.com/abstract=3478505 or http://dx.doi.org/10.2139/ssrn.3478505
Source: https://papers.ssrn.com/sol3/papers.cfm?abstr...

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