Reconciling negative return skewness with positive time-varying risk premia

Dimitra Kyriakopoulou and Christian Hafner

No 2022031, LIDAM Reprints ISBA from Université catholique de Louvain, Institute of Statistics, Biostatistics and Actuarial Sciences (ISBA)

Abstract: 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.

Keywords: Exponential GARCH; in-mean; risk premium; ICAPM; unconditional skewness; asymmetric distribution; portfolio selection; value-at-risk (search for similar items in EconPapers)
Pages: 28
Date: 2022-05-24
Note: In: Econometric Reviews, 2022, vol. 41(8), p. 877-894
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Persistent link: https://EconPapers.repec.org/RePEc:aiz:louvar:2022031

DOI: 10.1080/07474938.2022.2072323

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