Market Skewness Risk and the Cross-Section of Stock Returns

43 Pages Posted: 30 Sep 2009

See all articles by Bo Young Chang

Bo Young Chang

Bank of Canada

Peter Christoffersen

University of Toronto - Rotman School of Management; Copenhagen Business School; Aarhus University - CREATES

Kris Jacobs

University of Houston - C.T. Bauer College of Business

Date Written: September 29, 2009

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 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.

Keywords: skewness risk, cross-section, ICAPM, volatility risk, option-implied moments

JEL Classification: G12

Suggested Citation

Chang, Bo Young and Christoffersen, Peter and Jacobs, Kris, Market Skewness Risk and the Cross-Section of Stock Returns (September 29, 2009). Available at SSRN: https://ssrn.com/abstract=1480332 or http://dx.doi.org/10.2139/ssrn.1480332

Bo Young Chang (Contact Author)

Bank of Canada ( email )

234 Wellington St.
Ottawa, Ontario K1A0G9
Canada
613-782-8936 (Phone)
613-782-7136 (Fax)

HOME PAGE: http://www.bankofcanada.ca/author/bo-young-chang-2/

Peter Christoffersen

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5P 3C4
Canada
416-946-5511 (Phone)

HOME PAGE: http://www.christoffersen.com

Copenhagen Business School

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Aarhus University - CREATES

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Kris Jacobs

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

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