Abstract
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).
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