Skewness Preference and Market Anomalies

Abstract

This study shows that investor preference for positively skewed payoffs is a common driver of mispricing across a wide range of market anomalies. Specifically, skewness-loving investors overweight overpriced stocks in their portfolios and in doing so contribute to the anomalies. Using a combined measure of mispricing based on 11 prominent anomaly strategies, we find that stocks with higher skewness are significantly more mispriced than are those with lower skewness. A factor that captures skewness-related mispricing significantly improves the performance of conventional asset pricing models in explaining the abnormal returns of anomaly strategies.

Keywords: Anomalies, commonality, skewness preference, mispricing, trading strategies.

JEL Classification: G02, G12, G14