Time-Varying Conditional Skewness and the Market Risk Premium
Akhtar R. Siddique
Office of the Comptroller of the Currency - Enterprise Risk Analysis Division
Campbell R. Harvey
Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)
March 9, 2000
Single factor asset pricing models face two major hurdles: the problematic time-series properties of the ex ante market risk premium and the inability of the risk measure to account for a substantial degree of the cross-sectional variation of expected excess returns. We provide an explanation for the first failure using the following intuition: if investors know that the asset returns have conditional skewness given the information known today, the expected excess returns should include rewards for accepting skewness. We formalize this intuition with an asset pricing model which incorporates conditional skewness. We decompose the expected excess returns into components due to conditional variance and skewness. Our results show that conditional skewness is important and, when combined with the economy-wide reward for skewness, helps explain the time-variation of the ex ante market risk premiums. Conditional skewness has greater success in explaining the ex ante risk premium for the world portfolio than for the U.S. portfolio.
Number of Pages in PDF File: 34
Keywords: Risk premium, reward to risk, volatility, skewness, risk premium puzzle, reward for skewness
JEL Classification: G12working papers series
Date posted: September 9, 2005
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