Conditional Coskewness and Asset Pricing

41 Pages Posted: 10 Feb 2006 Last revised: 10 Mar 2008

Daniel R. Smith

Queensland University of Technology - School of Economics and Finance; Simon Fraser University; Financial Research Network (FIRN)

Date Written: May 2006

Abstract

We explore the empirical usefulness of conditional coskewness to explain the cross-section of equity returns. We find that coskewness is an important determinant of the returns to equity, and that the pricing relationship varies through time. In particular we find that when the conditional market skewness is positive investors are willing to sacrifice 7.87% annually per unit of gamma (a standardized measure of coskewness risk) while they only demand a premium of 1.80% when the market is negatively skewed. A similar picture emerges from the coskewness factor of Harvey and Siddique (1999) (a portfolio that is long stocks with small coskewness with the market and short high coskewness stocks) which earns 5.00% annually when the market is positively skewed but only 2.81% when the market is negatively skewed. The conditional two-moment CAPM and a conditional Fama and French (1993) three-factor model are rejected, but a model which includes coskewness is not rejected by the data. The model also passes a structural break test which many existing asset pricing models fail.

Keywords: GMM, Asset Pricing, Conditional, Nonlinear, Coskewness, Pricing Kernel

JEL Classification: C12, C52, G12

Suggested Citation

Smith, Daniel R., Conditional Coskewness and Asset Pricing (May 2006). Available at SSRN: https://ssrn.com/abstract=882836 or http://dx.doi.org/10.2139/ssrn.882836

Daniel Robert Smith (Contact Author)

Queensland University of Technology - School of Economics and Finance ( email )

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Simon Fraser University ( email )

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Canada
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HOME PAGE: http://www.sfu.ca/~drsmith

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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