Can the Premium for Idiosyncratic Tail Risk be Explained by Exposures to its Common Factor?

Stocks in the highest idiosyncratic tail risk decile earn 7.3% higher average annual returns than in the lowest. I propose a risk-based explanation for this premium, in which shocks to intermediary funding cause idiosyncratic tail risk to follow a strong factor structure, and the factor, common idiosyncratic tail risk (CITR), comoves with intermediary funding. Consequently, firms with high idiosyncratic tail risk have high exposure to CITR shocks, and command a risk premium due to their low returns when intermediary constraints tighten. To test my explanation, I create a novel measure of idiosyncratic tail risk that is estimated using high-frequency returns, and theoretically establish its time-aggregation properties. Consistent with my explanation, CITR shocks are procyclical, correlated to intermediary factors, priced in assets, and explain the idiosyncratic tail risk premium. Furthermore, volume tail risk also earns a premium, follows a strong factor structure, and its common factor is priced. This duality of idiosyncratic tail risk and volume tail risk provides evidence for my risk-based explanation, and further supports the hypothesis that intermediaries' large trades cause idiosyncratic tail risk and volume tail risk from Gabaix et al. (2006)