Skewness‐Aware Asset Allocation: A New Theoretical Framework and Empirical Evidence

32 Pages Posted: 18 Feb 2012

See all articles by Cheekiat Low

Cheekiat Low

National University of Singapore (NUS) - Department of Accounting

Dessislava Pachamanova

Babson College

Melvyn Sim

National University of Singapore (NUS) - NUS Business School

Date Written: April 2012

Abstract

This paper presents a new measure of skewness, skewness‐aware deviation, that can be linked to prospective satisficing risk measures and tail risk measures such as Value‐at‐Risk. We show that this measure of skewness arises naturally also when one thinks of maximizing the certainty equivalent for an investor with a negative exponential utility function, thus bringing together the mean‐risk, expected utility, and prospective satisficing measures frameworks for an important class of investor preferences. We generalize the idea of variance and covariance in the new skewness‐aware asset pricing and allocation framework. We show via computational experiments that the proposed approach results in improved and intuitively appealing asset allocation when returns follow real‐world or simulated skewed distributions. We also suggest a skewness‐aware equivalent of the classical Capital Asset Pricing Model beta, and study its consistency with the observed behavior of the stocks traded at the NYSE between 1963 and 2006.

Keywords: skewness, optimal portfolio allocation, prospective satisficing measures, beta

Suggested Citation

Low, Cheekiat and Pachamanova, Dessislava and Sim, Melvyn, Skewness‐Aware Asset Allocation: A New Theoretical Framework and Empirical Evidence (April 2012). Mathematical Finance, Vol. 22, Issue 2, pp. 379-410, 2012, Available at SSRN: https://ssrn.com/abstract=2007384 or http://dx.doi.org/10.1111/j.1467-9965.2010.00463.x

Cheekiat Low (Contact Author)

National University of Singapore (NUS) - Department of Accounting ( email )

1 Business Link
Singapore, 117592
Republic of Singapore
+65 7814313 (Phone)

Dessislava Pachamanova

Babson College ( email )

Babson Park, MA 02157
United States
781-235-1200 (Phone)
781-239-6414 (Fax)

Melvyn Sim

National University of Singapore (NUS) - NUS Business School ( email )

1 Business Link
Singapore, 117592
Singapore

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