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The Risk of Individual Stocks' Tail Dependence with the Market and Its Effect on Stock Returns

Author

Listed:
  • Guobin Fan

    (Southwestern University of Finance and Economics [Chengdu, China])

  • Eric Girardin

    (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique)

  • Wong K. Wong

    (Cardiff University)

  • Yong Zeng

    (Wuhan Institute of Physics and Mathematics - The Chinese Academy of Sciences, UCAS - University of Chinese Academy of Sciences [Beijing] - CAS - Chinese Academy of Sciences [Beijing])

Abstract
Traditional beta is only a linear measure of overall market risk and places equal emphasis on upside and downside risks, but actually the latter is always much stronger probably due to the trading mechanism like short-sale constraints. Therefore, this paper employs the nonlinear measure, tail dependence, to measure the extreme downside risks that individual stocks crash together with the whole market and investigates whether such tail dependence risks will affect stock returns. Our empirical evidence based on Shanghai A shares confirms that most stocks display nonnegligible tail dependence with the whole market, and, more importantly, such tail dependence risks can indeed provide additional information beyond beta and other factors for asset pricing. In cross-sectional regression, it is proved that this tail dependence does help to explain monthly returns on Shanghai A shares, whereas the time-series regression further indicates that mimicking portfolio returns for tail dependence can capture strong common variation of Shanghai A stock returns.

Suggested Citation

  • Guobin Fan & Eric Girardin & Wong K. Wong & Yong Zeng, 2015. "The Risk of Individual Stocks' Tail Dependence with the Market and Its Effect on Stock Returns," Post-Print hal-01457389, HAL.
    • Handle: RePEc:hal:journl:hal-01457389
    DOI: 10.1155/2015/980768
    Note: View the original document on HAL open archive server: https://amu.hal.science/hal-01457389
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    References listed on IDEAS

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