Skewness Risk Premium: Theory and Empirical Evidence

Christian Wolff, Thorsten Lehnert and Yuehao Lin

No 9349, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Using an equilibrium asset and option pricing model in a production economy under jump diffusion, we show theoretically that the aggregated excess market returns can be predicted by the skewness risk premium, which is constructed to be the difference between the physical and the risk-neutral skewness. In an empirical application of the model using more than 20 years of data on S&P500 index options, we find that, in line with theory, risk-averse investors demand risk-compensation for holding stocks when the market skewness risk premium is high. However, when we characterize periods of high and low risk aversion, we show that in line with theory, the relationship only holds when risk aversion is high. In periods of low riskaversion, investors demand lower risk compensation, thus substantially weakening the skewness-risk-premium-return trade off.

Keywords: Asset pricing; Skewness risk premium; Option markets; Central moments; Investor sentiment; Risk aversion (search for similar items in EconPapers)
JEL-codes: C15 G12 (search for similar items in EconPapers)
Date: 2013-02
New Economics Papers: this item is included in nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Skewness risk premium: Theory and empirical evidence (2019)
Working Paper: Skewness Risk Premium: Theory and Empirical Evidence (2014)
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