Coskewness Risk Decomposition, Covariation Risk, and Intertemporal Asset Pricing
Posted: 11 Sep 2017 Last revised: 31 Jan 2019
Date Written: June 24, 2017
We develop an intertemporal asset pricing model where cash flow news, discount rate news, and their second moments are priced by the market. This model generalizes the market return decomposition framework, showing that intertemporal considerations imply a decomposition of squared market returns (coskewness risk). Our model accounts for 68% of the return variation across size-, book-to-market–, momentum-, investment-, and profitability-sorted portfolios for a modern U.S. sample period. Further, our findings highlight the importance of covariation risk, that is, the risk of simultaneous unfavorable shocks to cash flows and discount rates, in understanding equity risk premia.
Keywords: Asset pricing; coskewness risk; cash flow news; discount rate news; covariation risk
JEL Classification: G12; G14
Suggested Citation: Suggested Citation