Left-tail momentum: underreaction to bad news, costly arbitrage and equity returns

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Official URL: http://dx.doi.org/10.1016/j.jfineco.2019.07.006

This paper documents a significantly negative cross-sectional relation between left-tail risk and future returns on individual stocks trading in the U.S. and international countries. We provide a behavioral explanation to this anomaly based on the idea that investors underestimate the persistence in left-tail risk and overprice stocks with large recent losses. Thus, low returns in the left-tail of the distribution persist into the future causing left-tail return momentum. We find that the left-tail risk anomaly is stronger for stocks that are more likely to be held by retail investors, that receive less investor attention and that are costlier to arbitrage.