The effect of Size, Value and Idiosyncratic Risk Anomalies on the Relationship between Tail Risk and Stock Excess Returns

Capital market anomalies are caused by factors haven’t been considered in capital asset pricing models. The theories of extreme value are one of the arguments for explaining anomalies. On the basis of theory of extreme value, the tail risk is an adverse event that can have a negative impact on stock excess returns. Therefore, this study aimed at investigate the effect of combining the anomalies of size, value and idiosyncratic risk with tail on stock excess returns. In this study, we have used two criteria of Aggregate Tail Risk and Hybrid Tail Covariance Risk to measure the tail risk. For this purpose, using the systematic removal method, a sample of 136 firms listed on the Tehran Stock Exchange in the period from 2008 to 2019 was selected. The research hypotheses were tested using the Five-Factor Fama and French model (2015). The results suggested that the combination of size and tail risk portfolio and the combination of value and tail risk portfolio have a negative effect on excess return on risk. The results also showed that the combination of idiosyncratic risk and tail risk portfolio has a positive and significant effect on stock excess returns. Therefore, by combining these portfolios, investors can gain excess returns in the Iranian capital market. The results generally indicated that tail risk can be added to asset pricing models in addition to the variables of the five-factor Fama and French model.