Higher-Moment Risk

62 Pages Posted: 15 Nov 2017 Last revised: 19 Feb 2020

See all articles by Niels Joachim Gormsen

Niels Joachim Gormsen

University of Chicago - Booth School of Business

Christian Skov Jensen

Bocconi University

Date Written: February 18, 2020

Abstract

We use a new method to estimate ex ante higher order moments of stock market returns from option prices. Even and odd number higher order moments are strongly negatively correlated, creating periods where the return distribution is riskier because it is more left-skewed and fat tailed. The higher-moment risk increases in good times when variance is lower and prices are higher. This time variation is inconsistent with disaster-based models where disaster risk, and thus higher-moment risk, peaks in bad times. The variation in higher-moment risk also has important implications for investors as it causes the probability of a three-sigma loss on the market portfolio to vary from 0.7% to 1.9% percent over the sample, peaking in calm periods such as just before the onset of the financial crisis.

Keywords: asset pricing, financial economics, higher order moments, tail risk

JEL Classification: G00, G1, G12, G13, G17

Suggested Citation

Gormsen, Niels Joachim and Jensen, Christian Skov, Higher-Moment Risk (February 18, 2020). Available at SSRN: https://ssrn.com/abstract=3069617 or http://dx.doi.org/10.2139/ssrn.3069617

Niels Joachim Gormsen

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Christian Skov Jensen (Contact Author)

Bocconi University ( email )

Via Roentgen 1
Milano, MI 20136
Italy

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