Tail risk premiums versus pure alpha

Here, Yves Lempérière, Cyril Deremble, Trung-Tu Nguyen, Philip Seager, Marc Potters and Jean-Philippe Bouchaud present extensive evidence that risk premium is strongly correlated with tail-risk skewness but very little with volatility. They introduce a new, intuitive definition of skewness and elicit a linear relation between the Sharpe ratio of various risk premium strategies and their negative skewness. They find a clear exception to this rule: trend following that has positive skewness and positive excess returns, suggesting that some strategies are not risk premiums but genuine market anomalies. Based on their results, they propose an objective criterion to assess the quality of a risk-premium portfolio

chart showing underlying performance of the asset


One of the pillars of modern finance theory is the concept of risk premium, ie, that more risky investments should, in the long run, also be more profitable. If this was not the case, investors would divest, prices would fall and expected returns would rise until they become attractive again. Cogent as it may sound, this conclusion appears to be in contradiction with direct empirical observations. For example, several authors have reported an inverted

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