Coskewness Risk Decomposition, Covariation Risk, and Intertemporal Asset Pricing

Petko S. Kalev, Konark Saxena and Leon Zolotoy

Journal of Financial and Quantitative Analysis, 2019, vol. 54, issue 1, 335-368

Abstract: We develop an intertemporal asset pricing model where cash-flow news, discount-rate news, and their second moments are priced by the market. This model generalizes the market-return decomposition framework, showing that intertemporal considerations imply a decomposition of squared market returns (coskewness risk). Our model accounts for 68% of the return variation across portfolios sorted by size, book-to-market ratio, momentum, investment, and profitability for a modern U.S. sample period. Further, our findings highlight the importance of covariation risk, that is, the risk of simultaneous unfavorable shocks to cash flows and discount rates, in understanding equity risk premia.

Date: 2019
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