Reconciling negative return skewness with positive time-varying risk premia

One of the implications of the intertemporal capital asset pricing model (ICAPM) is a positive and linear relationship between the conditional mean and conditional variance of returns to the market portfolio. Empirically, however, it is often observed that there is a negative skewness in equity retu...

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Bibliographic Details
Published in:Econometric reviews 2022-09, Vol.41 (8), p.877-894
Main Authors: Kyriakopoulou, Dimitra, Hafner, Christian M.
Format: Article
Language:English
Subjects:
Asset pricing
asymmetric distribution
Asymmetry
Econometrics
Exponential GARCH
ICAPM
in-mean
Innovations
portfolio selection
Risk
risk premium
Securities markets
Skewed distributions
Skewness
Specification
unconditional skewness
Value
value-at-risk
Citations: Items that this one cites
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Summary:One of the implications of the intertemporal capital asset pricing model (ICAPM) is a positive and linear relationship between the conditional mean and conditional variance of returns to the market portfolio. Empirically, however, it is often observed that there is a negative skewness in equity returns. This article shows that a negative skewness is only compatible with a positive risk premium if the innovation distribution is asymmetric with a negative skewness. We extend recent work using the EGARCH-in-Mean specification to allow for asymmetric innovations, and give results for the unconditional skewness of returns. We apply the model to the prediction of Value-at-Risk of the largest stock market indices, and demonstrate its good performance. Keywords: Exponential GARCH, in-mean, risk premium, ICAPM, unconditional skewness, asymmetric distribution, portfolio selection, Value-at-Risk.
ISSN:0747-4938
1532-4168
DOI:10.1080/07474938.2022.2072323