Volatility-Dependent Skewness-Preference and Equity Investment Strategies

Abstract

The present paper proposes a variance-dependent explanation for the contradiction between skewness-preference and inferior post-returns for high-skewness stocks. We emphasize an overlooked aspect measured by skewness as a risk proxy—the return uncertainty of extreme events. The findings show that during periods of high market volatility, investors may dislike stocks with a large skewness due to fear of an uncertain outcome. Thus, a negative relation between the return and skewness occurs. Conversely, positive associations emerge under low-volatility-risk environments. Finally, the return-skewness nexus conditional on the variance is demonstrated to possess return predictability and can adjust portfolios well.

Keywords: skewness; volatility; return prediction; portfolio stock selection

JEL Classification: C14; C53; G11; G12