Volatility versus Tail Risk: Which One Is Compensated in Equity Funds?

Abstract

Research that has led to the low-volatility anomaly in cross-sectional stocks from a similar universe indicates that volatility is not compensated with a volatility premium. The authors find evidence of a risk premium, but it depends on the definition or measure of risk. Tail risk measures the probability of having significant losses, and should be what investors care about the most. This article investigates several risk measures, including volatility and tail risk, and finds that volatility is not compensated. Tail risk, however, is compensated with higher expected return in both U.S. and non-U.S. equity funds.