Are Market Anomalies Really Anomalies? The Importance of Systematic Skewness in Asset Pricing

Eric Danckwardt-Lillieström & Niklas Landin Olsen

Student thesis: Master thesis

Abstract

This paper investigates how important systematic skewness, or equivalently coskewness, is in asset pricing and how it is linked to the well-documented market anomalies; size, value, momentum, and betting-againstbeta. This is motivated by the failure of CAPM to account for systematic skewness and that trading strategies exploiting the anomalies have been shown to exhibit skewed return distributions. This study used data from the Swedish stock market from 1990 to 2017. First, a coskewness risk premium was created by constructing ten portfolios on the basis of stocks‟ coskewness. This was used to investigate the power of coskewness to predict future returns. Similarly, four different risk premiums were created to capture the market anomalies. These risk premiums were separately regressed on the coskewness risk premium together with the excess market return to examine whether they capture the same underlying risk and whether the profitability of the exploiting trading strategies decreases after controlling for coskewness risk. Furthermore, two different higher-moment asset pricing models were created to investigate whether coskewness helps explain the crosssectional return variation between the portfolios that were created to capture the market anomalies. We find that coskewness, on average, require a risk premium of 1.94% on an annual basis and seem to have important implications for asset pricing. Furthermore, the results provide intriguing evidence that coskewness is closely linked to the market anomalies and particularly to the betting-against-beta and value anomaly. Even though coskewness cannot alone explain the existence of the market anomalies, the result suggests that coskewness might serve as an important piece of the puzzle regarding their presence

EducationsMSc in Finance and Investments, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2017
Number of pages135