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Portfolio Pricing with Measures of Conditional Skewness and Kurtosis

Lelis, Natalia LU (2011) NEKM03 20111
Department of Economics
Abstract
On the ground of a highly dynamic economic environment, the necessity for time-varying risk
measures emerged. Inclusion of higher-order conditional moments in asset pricing models is a
very common topic in recent research articles. The present essay was inspired by the seminal
work of Harvey and Siddique (1999), who proposed estimation of time-varying skewness and
pricing its explanatory power by a conditional three-moment CAPM. By estimating the first four
conditional return moments I confirm previous findings about their high persistence, after which
these risk measures are employed in testing the four-moment conditional CAPM. I analyze both
time-series and cross-sectional regression results for 25 portfolios formed on different... (More)
On the ground of a highly dynamic economic environment, the necessity for time-varying risk
measures emerged. Inclusion of higher-order conditional moments in asset pricing models is a
very common topic in recent research articles. The present essay was inspired by the seminal
work of Harvey and Siddique (1999), who proposed estimation of time-varying skewness and
pricing its explanatory power by a conditional three-moment CAPM. By estimating the first four
conditional return moments I confirm previous findings about their high persistence, after which
these risk measures are employed in testing the four-moment conditional CAPM. I analyze both
time-series and cross-sectional regression results for 25 portfolios formed on different criteria
(industry, size, momentum). In the time-series approach, conditional kurtosis is highly correlated
with covariance and adds no pricing power. Neither conditional skewness has a well-defined
impact in determining return compensation. However, in cross-sectional regressions, kurtosis
risk is priced in most of the crises years, but its risk premium has the opposite sign. Investors
prefer more kurtosis to less, suggesting that kurtosis is still much underestimated in financial
markets during crises. Skewness is still insignificantly priced in cross-sectional CAPM.
Altogether the four-moment cross-sectional CAPM performs better than its two-moment
counterpart. (Less)
Please use this url to cite or link to this publication:
author
Lelis, Natalia LU
supervisor
organization
course
NEKM03 20111
year
type
H1 - Master's Degree (One Year)
subject
keywords
Asset Pricing, CAPM, Time-varying Moments, Conditional Skewness, Conditional Kurtosis
language
English
id
1974962
date added to LUP
2011-06-15 12:46:08
date last changed
2011-06-15 12:46:08
@misc{1974962,
  abstract     = {On the ground of a highly dynamic economic environment, the necessity for time-varying risk
measures emerged. Inclusion of higher-order conditional moments in asset pricing models is a
very common topic in recent research articles. The present essay was inspired by the seminal
work of Harvey and Siddique (1999), who proposed estimation of time-varying skewness and
pricing its explanatory power by a conditional three-moment CAPM. By estimating the first four
conditional return moments I confirm previous findings about their high persistence, after which
these risk measures are employed in testing the four-moment conditional CAPM. I analyze both
time-series and cross-sectional regression results for 25 portfolios formed on different criteria
(industry, size, momentum). In the time-series approach, conditional kurtosis is highly correlated
with covariance and adds no pricing power. Neither conditional skewness has a well-defined
impact in determining return compensation. However, in cross-sectional regressions, kurtosis
risk is priced in most of the crises years, but its risk premium has the opposite sign. Investors
prefer more kurtosis to less, suggesting that kurtosis is still much underestimated in financial
markets during crises. Skewness is still insignificantly priced in cross-sectional CAPM.
Altogether the four-moment cross-sectional CAPM performs better than its two-moment
counterpart.},
  author       = {Lelis, Natalia},
  keyword      = {Asset Pricing,CAPM,Time-varying Moments,Conditional Skewness,Conditional
Kurtosis},
  language     = {eng},
  note         = {Student Paper},
  title        = {Portfolio Pricing with Measures of Conditional Skewness and Kurtosis},
  year         = {2011},
}