Anxiety in Returns

Abstract

We provide empirical evidence that risk-averse investors become anxious about investments in stocks whose realized losses reveal the downside of risk. Contrary to short-term reversal and in support of convex risk aversion, the latter stocks yield significantly lower returns in the subsequent period. Our findings are based on a novel measure of time-varying risk aversion, but can also be observed when using a well-established measure of risk aversion. Moreover, anxiety predicts cross-sectional returns in out-of-sample tests, suggesting that risk-averse investors’ preferences drive empirical risk premia.