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Market Skewness Risk and the Cross-Section of Stock Returns

Author

Listed:
  • Chang, Bo Young

    (McGill University)

  • Christoffersen, Peter

    (McGill University and Copenhagen Business School)

  • Jacobs, Kris

    (University of Houston and University of McGill)

Abstract

The cross-section of stock returns has substantial exposure to risk captured by higher moments in market returns. We estimate these moments from daily S&P 500 index option data. The resulting time series of factors are thus genuinely conditional and forward-looking. Stocks with high sensitivities to innovations in implied market volatility and skewness exhibit low returns on average, whereas those with high sensitivities to innovations in implied market kurtosis exhibit somewhat higher returns on average. The results on market skewness risk are robust to various permutations of the empirical setup. The estimated premium for bearing market skewness risk is between -3.72% and -5.76% annually. This market skewness risk premium is economically significant and cannot be explained by other common risk factors such as the market excess return or the size, book-to-market, momentum, and market volatility factors, or by firm characteristics. Using ICAPM intuition, the negative price of market skewness risk indicates that it is a state variable that negatively affects the future investment opportunity set.

Suggested Citation

  • Chang, Bo Young & Christoffersen, Peter & Jacobs, Kris, 2010. "Market Skewness Risk and the Cross-Section of Stock Returns," Working Papers 11-18, University of Pennsylvania, Wharton School, Weiss Center.
    • Handle: RePEc:ecl:upafin:11-18
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    File URL: http://fic.wharton.upenn.edu/fic/papers/11/11-18.pdf
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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