Modeling Skewness in Portfolio Choice

Abstract

Despite half a century of research, we still do not know the best way to model skewness of financial returns. We address this question by comparing the predictive ability and associated portfolio performance of several prominent skewness models in a sample of ten international equity market indices. Models that employ information from the option markets provide the best outcomes overall. We propose an option-based model that accounts for the skewness risk premium. This model offers the most informative forecasts of future skewness, the lowest prediction errors and the best portfolio performance in most of our tests

Keywords: Skewness modeling, Skewness Risk Premium, Portfolio choice

JEL Classification: G11, C58