TY - JOUR T1 - A Tale of Two Tails: Mortality, Size, Volatility, and EPU JF - The Journal of Portfolio Management DO - 10.3905/jpm.2021.1.302 SP - jpm.2021.1.302 AU - Maggie Copeland AU - Thomas Copeland AU - Zhitong Lai Y1 - 2021/10/13 UR - https://pm-research.com/content/early/2021/10/13/jpm.2021.1.302.abstract N2 - The firm’s equity can be valued by focusing on two tails that involve optionality. Equity shareholders have two call options on the firm’s value: an upside potential benefit call and a downside risk protection call. An optimal capital structure can be derived from optimizing these two call options. We navigate different size and volatility portfolios by examining their mortality rate for the period between 1960 and 2019. Significantly higher unfavorable mortality rates are associated with the small-cap and high-volatility portfolios. Furthermore, the difference in unfavorable mortality rates among portfolios for size and volatility is exceptionally large. The difference in mortality rates can reach 47% for a 10-year mortality horizon. The differences are not stationary over time and can be best explained by uncertainty indexes such as EPU and VIX.Key Findings▪ The shareholders of equity have two call options on the firm’s value: an upside potential benefit call and a downside risk protection call. An optimal capital structure can be derived from optimizing these two call options. ▪ Significantly higher unfavorable mortality rates are associated with the small-cap and high-volatility portfolios. Furthermore, the difference in unfavorable mortality rates among portfolios for size and volatility is exceptionally large. The difference in unfavorable mortality rates for size and volatility can reach 47% for a 10-year mortality horizon. ▪ These differences in unfavorable mortality are not stationary over time and can be best explained by uncertainty indexes such as EPU and VIX. During crises and intervals of high uncertainty in the economy, small-cap and high-volatility portfolios suffer much more relative to large-cap or low-volatility portfolios owing to the increase in the future unfavorable mortality. ER -