Dear all, if one return series is positively skewed or negatively skewed, how one investor can benefit out of this. Whether positively skewed is good or negatively skewed is good for an investor. Kindly justify your answer with an example.
There are two things at work - one is that (most) returns are bounded by a zero lower bound for price, so they are automatically skewed since there is a theoretical infinite upper bound. Second is that human beings fear a loss much more than the utility from a comparable gain, so there will always be a skew to protect losses, which manifests itself in the implied volatilities of options prices. If you think the skew is too high (or low) you can use options spreads to sell the "skew" or alternatively buy it if it is underpriced.
For an example, see:
http://www.optionstrategist.com/blog/2013/03/volatility-skew-information
Other things being equal and assuming rationality, investors in general would prefer assets with positive skewness, so these would be expected to trade at higher prices (or offer lower expected returns). The reason is that investors would be willing to pay a premium for assets whose return distribution are concentrated on the positive side.
Theoretically, if asset returns are skewed or leptokurtic, then beta alone is not sufficient to price assets and one needs to include higher moments in the pricing model. Then what matters is the amount of skewness an asset adds to the portfolio as the market moves (coskewness measure). This leads to the Higher Moment CAPM.
There is some evidence that higher moment, including skewness, matter in asset pricing. The following references and references therein might be useful:
- Kraus, A., & Litzenberger, R. (1976). Skewness Preference and the Valuation of Risky Assets. Journal of Finance, 21(4), 1085-1094.
- Lim, K. (1989). A new test of the three-moment capital asset pricing model.
Journal of Financial and Quantitative Analysis, 24 (2), 205-216. http://dx.doi.org/10.2307/2330772
- Hwang, S., & Satchell, S. (1999). Modelling Emerging Market Risk Premia using Higher Moments. International Journal of Finance and Economics, 4 (4), 271-296.
- Harvey, C., & Siddique, A. (2000). Conditional skewness in asset pricing tests.
The Journal of Finance, 55 (3), 1263-1295.
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