RT Journal Article
SR Electronic
T1 Volatility-Dependent Skewness Preference
JF The Journal of Portfolio Management
FD Institutional Investor Journals
SP jpm.2021.1.295
DO 10.3905/jpm.2021.1.295
A1 Xiang Gao
A1 Kees G. Koedijk
A1 Zhan Wang
YR 2021
UL https://pm-research.com/content/early/2021/10/05/jpm.2021.1.295.abstract
AB In this article, the authors propose a variance-dependent explanation for the contradiction between skewness preference and low expected return concerning lottery stocks. They emphasize an overlooked aspect of skewness as a risk measure: the return uncertainty of extreme events. They show that, during periods of low market volatility, investors dislike large-skewness securities owing to a fear of uncertain results. Thus, one observes a positive relation between skewness and expected return because the security is currently undervalued. Conversely, negative associations occur in high-volatility environments. This conditional skewness–return nexus is demonstrated to possess return predictability and can help in adjusting portfolios with profitable buying and selling decisions.Key Findings▪ The authors propose variance-dependent skewness to reconcile the skewness preference for lottery stocks with their actual low expected returns.▪ They emphasize skewness as a risk measure of the return uncertainty of extreme events.▪ The authors construct portfolios based on the return predictability of skewness conditional on volatility and show that these portfolios remain profitable after considering transaction costs and restrictions on short sales.