Extreme downside risk in the cross-section of asset returns

Abstract

Extreme movements in financial markets are not always reflected equally in individual stocks. Identifying which firms are unable to absorb shocks is a challenge. This paper considers extreme downside risk, an extension to Ang et al.’s (2006) downside risk framework, and the value in separating the sensitivity between extreme and non-extreme downside risk. I find that the cross-sectional average annual excess return between high and low extreme downside exposure stocks is around 3.9%. The extension differentiates itself for young firms or firms that have not experienced a severe crisis, where the risk premium ranges from 2.4% to 10.4%.