The tale of two tails and stock returns for two major emerging markets

In this study, we examine the relationship between tail measures and stock return for China and India using data from 2000 to 2021. For both the markets, left and right tails exhibit a negative relationship with stock returns and confirm the tail risk puzzle and tail preference, respectively. Tail-based anomalies seem to be a small stock phenomenon, except for the right tail effect in case of India. We find that the two-tail strategy outperforms one-tail strategies for both markets. We confirm that the tail anomaly is primarily a behavioral phenomenon driven by both retail and institutional investors. Market and firm-level sentiments tend to play a more critical role in India than in China. A negative relationship exists between the change in the tail and expected returns for both markets. Contrary to recent research, the change in the tail factor does not explain tail-based returns. Chinese and Indian investors prefer tail risk irrespective of the initial capital state, contrasting with the prospect theory. Investor attention impacts expected returns in both markets, but Indian investors exhibit limited attention bias for both left and right-tail-based information, which is not the case in China. The findings are pertinent for policymakers and global investors.

JEL Codes G11, G12, G23, G40.