Lotto, How to Win? Skew Timing Strategies

46 Pages Posted: 4 May 2016

See all articles by Jian Chen

Jian Chen

Xiamen University - School of Economics

Yangshu Liu

Xiamen University - School of Management

Jun Tu

Singapore Management University - Lee Kong Chian School of Business

Date Written: April 26, 2016

Abstract

In this paper, we investigate whether the “lotto investor” can benefit from the time-varying skewness of market portfolio and how to capture the gain using skew timing strategies. We find that empirically applying the mean-variance-skewness (M-V-S) rule of Mitton and Vorkink (2007) generates similar performance as that of traditional mean-variance rule, because the optimal weight of M-V-S still mainly depends on the mean and variance unless the forecasted skewness is extremely large. To improve the M-V-S, we suggest combining two constrained versions of M-V-S, namely the mean-variance (M-V) and mean-skewness (M-S). Discarding the variance, the M-S fully considers the usefulness of skewness and the optimal weight solely depends on mean and skewness. However, M-S investor probably suffers huge loss due to forecasting errors. Combining the M-V with M-S should theoretically perform better than individual rules, and hence better than the M-V-S rule. Empirically, we find that the combination rule indeed generates superior performance, in terms of certainty equivalent returns, Sharpe ratios, and skewness of portfolio returns distribution.

Keywords: Mean-variance-skewness, Asset allocation, Realized skewness, Skewness forecasting

JEL Classification: C22, C53, G11, G12, G17

Suggested Citation

Chen, Jian and Liu, Yangshu and Tu, Jun, Lotto, How to Win? Skew Timing Strategies (April 26, 2016). Available at SSRN: https://ssrn.com/abstract=2774880 or http://dx.doi.org/10.2139/ssrn.2774880

Jian Chen

Xiamen University - School of Economics ( email )

422 Siming Nan Road
Xiamen, Fujian 361005
China

Yangshu Liu (Contact Author)

Xiamen University - School of Management ( email )

No.422 Siming Nan Road
Xiamen, Fujian 361005
China

Jun Tu

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
#04-01
Singapore, 178899
Singapore

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