Average Skewness Matters!

Abstract

Average skewness, which is defined as the average of monthly skewness values across firms, performs well at predicting future market returns. This result still holds after controlling for the size or liquidity of the firms or for current business cycle conditions. We also find that average skewness compares favorably with other economic and financial predictors of subsequent market returns. We consider two out-of-sample allocation exercises, one based on predictive regressions and the other based on the sign of the variable. In both cases, average skewness generates superior performance, in particular when it is introduced in conjunction with the current market return.

Keywords: return predictability, average skewness, idiosyncratic skewness

JEL Classification: G11, G12, G14, G17