Long-Horizon Stock Returns Are Positively Skewed

66 Pages Posted: 29 Apr 2021

See all articles by Adam Farago

Adam Farago

University of Gothenburg - Centre for Finance

Erik Hjalmarsson

University of Gothenburg - Centre for Finance

Date Written: April 28, 2021

Abstract

At long horizons, multiplicative compounding induces strong-to-extreme positive skewness into stock returns; the magnitude of the effect is primarily determined by single-period volatility. Consequently, at horizons greater than five years, returns --individual or portfolio-- will be positively skewed under reasonable parametrizations. From an investor perspective, the strong positive skewness implies that the mean compound return will serve as a poor guide for typical long-horizon outcomes. Moreover, the large effects of compounding on higher-order moments are shown to affect the validity of Taylor expansions used to approximate preferences for skewness, when applied to returns of annual or longer horizons.

Keywords: Compound returns, Long-run returns, Portfolio choice, Skewness

JEL Classification: C58, G11, G12, G17

Suggested Citation

Farago, Adam and Hjalmarsson, Erik, Long-Horizon Stock Returns Are Positively Skewed (April 28, 2021). Available at SSRN: https://ssrn.com/abstract=3835813 or http://dx.doi.org/10.2139/ssrn.3835813

Adam Farago (Contact Author)

University of Gothenburg - Centre for Finance ( email )

Box 640
Gothenburg, 405 30
Sweden

Erik Hjalmarsson

University of Gothenburg - Centre for Finance ( email )

Box 640
Gothenburg, 403 50
Sweden

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