Aggregate Tail Risk and Expected Returns

We examine the connection between tail risk — as measured in Kelly and Jiang (2014) — and the cross-section of expected returns. In conditional predictive regression systems and vector-autoregressions of the market portfolio and the long- and shoresides of the Fama-French factor portfolios, the tail measure has very weak marginal explanatory power. If anything, tail risk appears to forecast discount rates — and not cash flows — which seems inconsistent with crash-based explanations of the importance of tail risk. We also compare the time series of tail risk to measures of aggregate uncertainty, a measure of funding risk, and three Treasury term structure factors. Tail risk Granger causes and is Granger caused by the level of the term structure, and the slope of the term structure Granger causes tail risk