Market Skewness Risk and the Cross-Section of Stock Returns
Bo Young Chang
Bank of Canada
University of Toronto - Rotman School of Management; Copenhagen Business School; University of Aarhus - CREATES
University of Houston - C.T. Bauer College of Business
September 29, 2009
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 high returns on average. The results on market skewness risk are extremely robust to various permutations of the empirical setup. The estimated premium for bearing market skewness risk is between -6.00% and -8.40% 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. 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.
Number of Pages in PDF File: 43
Keywords: skewness risk, cross-section, ICAPM, volatility risk, option-implied moments
JEL Classification: G12working papers series
Date posted: September 30, 2009
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