Risk Premia: Asymmetric Tail Risks and Excess Returns
25 Pages Posted: 30 Sep 2014
Date Written: September 29, 2014
We present extensive evidence that "Risk Premium" is strongly correlated with tail-risk skewness, but very little with volatility. We introduce a new, intuitive definition of skewness, and elicit a linear relationship between the Sharpe ratio of various risk premium strategies (Equity, Fama-French, FX Carry, short vol, bonds, credit) and their negative skewness. We find a clear exception to this rule: Trend Following (and perhaps the Fama-French "High minus Low"), that has positive skewness and positive excess return, suggesting that some strategies are not risk premia, but genuine market anomalies. Based on our results, we propose an objective criterion to assess the quality of a risk premium portfolio.
Keywords: Risk Premium, skewness, equity, carry trade
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