The Left-tail Risk and the Cross-section of Stock Returns: Evidence from China

Abstract

As a matter of fact, left-tail risk is a common risk in stock market. This study examines the linear correlation considering Value-at-Risk (VaR) and future stock returns within context of the Chinese main board stocks, particularly during periods marked by significant left-tail risk. Processing data from March 2014 to March 2024, this study concentrate to daily and monthly cross-section returns, along with other financial statistics. A suitable Fama-Macbeth regression using in this paper to exam the significance of left-tail risk. The key focus is to investigate the effect of VaR concerning future stock returns under downside market conditions, as indicated by the recent 23% drop in China’s benchmark CSI 300 index. The regression analysis indicates a significant negative correlation between VaR and future stock returns, suggesting that higher potential losses as indicated by VaR correspond with lower future returns. This outcome is contrary to traditional asset pricing theories which posit a positive risk-return relationship. The findings will attract attention of investors to consider extreme risk management of public stocks and contributes to the ongoing discussion on risk assessment in financial markets by highlighting the importance of integrating robust risk management tools like VaR in investment strategies, especially in volatile markets.