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Safety first, loss probability, and the cross section of expected stock returns.
Academic Journal
Recent studies show that loss probability (LP) is a decisive factor when people evaluate assets in laboratory experiments, suggesting a positive relationship between LP and expected stock returns. This corresponds to the classical "Safety-First" principle. We find strong empirical support for this prediction in the U.S. stock market. During our sample period, average risk-adjusted return differences between stocks in the two extreme LP deciles exceed 0.57% per month. The positive LP effect, characterized by the intention of some investors to pay low prices for high LP stocks, remains significant after controlling for traditional downside risk measures. [ABSTRACT FROM AUTHOR]