Time-Varying Conditional Skewness and the Market Risk Premium

34 Pages Posted: 9 Sep 2005  

Akhtar R. Siddique

Office of the Comptroller of the Currency - Enterprise Risk Analysis Division

Campbell R. Harvey

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER); Duke Innovation & Entrepreneurship Initiative

Date Written: March 9, 2000

Abstract

Single factor asset pricing models face two major hurdles: the problematic time-series properties of the ex ante market risk premium and the inability of the risk measure to account for a substantial degree of the cross-sectional variation of expected excess returns. We provide an explanation for the first failure using the following intuition: if investors know that the asset returns have conditional skewness given the information known today, the expected excess returns should include rewards for accepting skewness. We formalize this intuition with an asset pricing model which incorporates conditional skewness. We decompose the expected excess returns into components due to conditional variance and skewness. Our results show that conditional skewness is important and, when combined with the economy-wide reward for skewness, helps explain the time-variation of the ex ante market risk premiums. Conditional skewness has greater success in explaining the ex ante risk premium for the world portfolio than for the U.S. portfolio.

Keywords: Risk premium, reward to risk, volatility, skewness, risk premium puzzle, reward for skewness

JEL Classification: G12

Suggested Citation

Siddique, Akhtar R. and Harvey, Campbell R., Time-Varying Conditional Skewness and the Market Risk Premium (March 9, 2000). Available at SSRN: https://ssrn.com/abstract=795386 or http://dx.doi.org/10.2139/ssrn.795386

Akhtar R. Siddique

Office of the Comptroller of the Currency - Enterprise Risk Analysis Division ( email )

400 7th Ave
Washington, DC 20219
United States
202-649-5526 (Phone)

Campbell R. Harvey (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7768 (Phone)
919-660-8030 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Duke Innovation & Entrepreneurship Initiative ( email )

215 Morris St., Suite 300
Durham, NC 27701
United States

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