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Ex Ante Skewness and Expected Stock Returns

59 Pages Posted: 14 Dec 2009  

Jennifer S. Conrad

University of North Carolina Kenan-Flagler Business School

Robert F. Dittmar

University of Michigan, Stephen M. Ross School of Business

Eric Ghysels

University of North Carolina Kenan-Flagler Business School; University of North Carolina (UNC) at Chapel Hill - Department of Economics

Date Written: December 11, 2009

Abstract

We use a sample of option prices, and the method of Bakshi, Kapadia and Madan (2003), to estimate the ex ante higher moments of the underlying individual securities’ risk-neutral returns distribution. We find that individual securities’ volatility, skewness, and kurtosis are strongly related to subsequent returns. Specifically, we find a negative relation between volatility and returns in the
cross-section. We also find a significant relation between skewness and returns, with more negatively (positively) skewed returns associated with subsequent higher (lower) returns, while kurtosis is positively related to subsequent returns. We analyze the extent to which these returns relations represent compensation for risk. We find evidence that, even after controlling for differences in comoments, individual securities’ skewness matters. As an application, we examine whether idiosyncratic skewness in technology stocks might explain bubble pricing in Internet stocks. However, when we combine information in the risk-neutral distribution and a stochastic discount factor to estimate the implied physical distribution of industry returns, we find little evidence that the distribution of technology stocks was positively skewed during the bubble period – in fact, these stocks have the lowest skew, and the highest estimated Sharpe ratio, of all stocks in our sample.

Keywords: Skewness, kurtosis, co-skewness, stochastic discount factors

JEL Classification: G1, G12, G14

Suggested Citation

Conrad, Jennifer S. and Dittmar, Robert F. and Ghysels, Eric, Ex Ante Skewness and Expected Stock Returns (December 11, 2009). Available at SSRN: https://ssrn.com/abstract=1522218 or http://dx.doi.org/10.2139/ssrn.1522218

Jennifer S. Conrad

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Robert F. Dittmar

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Eric Ghysels (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

University of North Carolina (UNC) at Chapel Hill - Department of Economics ( email )

Gardner Hall, CB 3305
Chapel Hill, NC 27599
United States
919-966-5325 (Phone)
919-966-4986 (Fax)

HOME PAGE: http://www.unc.edu/~eghysels/

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