Skewness in Expected Macro Fundamentals and the Predictability of Equity Returns: Evidence and Theory

Abstract

We document that the first and third cross-sectional moments of the distribution of GDP growth rates made by professional forecasters can predict equity excess returns, a finding which is robust to controlling for a large set of well established predictive factors. We show that introducing time-varying skewness in the distribution of expected growth prospects in an otherwise standard endowment economy can substantially increase the model implied equity Sharpe ratios, and produce a large amount of fluctuation in equity risk premia.

The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2587412

Keywords: Skewness, Consumption, Macro-Finance, Recursive Preferences

JEL Classification: C22, C58, G12