The skewness risk premium in equilibrium and stock return predictability

In this study, we investigate the skewness risk premium in the financial market under a general equilibrium setting. Extending the long-run risks (LRR) model proposed by Bansal and Yaron (J Financ 59:1481–1509, 2004) by introducing a stochastic jump intensity for jumps in the LRR factor and the variance of consumption growth rate, we provide an explicit representation for the skewness risk premium, as well as the volatility risk premium, in equilibrium. On the basis of the representation for the skewness risk premium, we propose a possible reason for the empirical facts of time-varying and negative risk-neutral skewness. Moreover, we also provide an equity risk premium representation of a linear factor pricing model with the variance and skewness risk premiums. The empirical results imply that the skewness risk premium, as well as the variance risk premium, has superior predictive power for future aggregate stock market index returns, which are consistent with the theoretical implication derived by our model. Compared with the variance risk premium, the results show that the skewness risk premium plays an independent and essential role for predicting the market index returns.     

Implied volatility skews and stock return skewness and kurtosis implied by stock option prices

The Black-Scholes* option pricing model is commonly applied to value a wide range of option contracts. However, the model often inconsistently prices deep in-the-money and deep out-of-the-money options. Options professionals refer to this well-known phenomenon as a volatility ‘skew’ or ‘smile’. In this paper, we examine an extension of the Black-Scholes model developed by Corrado and Su that suggests skewness and kurtosis in the option-implied distributions of stock returns as the source of volatility skews. Adapting their methodology, we estimate option-implied coefficients of skewness and kurtosis for four actively traded stock options. We find significantly nonnormal skewness and kurtosis in the option-implied distributions of stock returns.     

Limited attention and the earnings announcement returns of past stock market winners

We document that stocks with the strongest prior 12-month returns experience a significant average market-adjusted return of 1.58% during the five trading days before their earnings announcements and a significant average market-adjusted return of −1.86% in the five trading days afterward. These returns remain significant even after accounting for transactions costs. We empirically test a limited attention explanation for these anomalous returns—that stocks with sharp run-ups tend to attract individual investors’ attention and investment dollars, particularly before their earnings announcements. Our analysis suggests that the trading decisions of individual investors are at least partly responsible for the return pattern that we observe.     

The financial conglomerate discount: Insights from stock return skewness

Diversified banks (i.e. financial conglomerates) trade often at a discount compared to matched portfolios of specialized stand-alone banks. The existing research explains this evidence primarily with inefficiencies in the cash flow management of banks. This article analyzes the financial conglomerate discount by focusing on the role of expected returns approximated by measures of stock return skewness. Our empirical findings support the hypothesis that diversified banks have less skewed stock returns, i.e. they are more likely to perform badly than non-diversified banks. Due to the lower skewness exposure investors demand higher future returns, thereby lowering corporate value. Although the conglomerate puzzle is observed across industries, the previous literature examines banks separately, as the financial industry is hardly comparable to other sectors. We follow this field of research and show that huge banks quote at a discount as diversification into investment banking activities affects negatively the corporate performance.     

Firm uncertainty and corporate policies: The role of stock return skewness

We study the interaction between firm uncertainty and corporate policies, emphasizing the role of skewness in the distribution of performance shocks reflected in stock returns. Conditional on volatility and other characteristics, firms with more negatively skewed performance shocks adopt more conservative policies, including greater cash holdings, a lower likelihood of dividend payments and increases in payout levels, and less financial leverage. These relationships are significant and robust for asymmetry proxies constructed from stock return innovations, in contrast to results for measures based on accounting performance shocks. This disparity highlights the importance of asymmetries in long-run performance shocks for corporate policy choices.     

Economic persistence,earnings informativeness,and stock return regularities

Review of Accounting Studies - We propose a simple framework for understanding accounting-based stock return regularities. A firm’s accounting reports provide noisy information about hidden...     

Negative earnings,positive earnings and stock return predictability: An empirical examination of market timing

We examine the predictive ability of earnings-price ratios or yields for the S&P 500 index. We decompose the aggregate earnings-price ratio into its positive and negative components (“winners” vs “losers”) and find that the negative component has the most predictive ability. We also find that the earnings-price measures forecast both future returns and earnings growth. Our models display substantial variation in explanatory power over time with forecast power resurfacing in the latter 1990s. We conclude that to the extent that earnings-price yields predict future S&P 500 returns, the negative earnings component is the driving factor.     

The information content of implied skewness and kurtosis changes prior to earnings announcements for stock and option returns

We use option prices to examine whether changes in stock return skewness and kurtosis preceding earnings announcements provide information about subsequent stock and option returns. We demonstrate that changes in jump risk premiums can lead to changes in implied skewness and kurtosis and are also associated with the mean and variability of the stock price response to the earnings announcement. We find that changes in both moments have strong predictive power for future stock returns, even after controlling for implied volatility. Additionally, changes in both moments predict call returns, while put return predictability is primarily linked to changes in skewness.     

Qualified audit opinions and stock prices: Information content,announcement dates,and concurrent disclosures

We investigate whether announcements of ‘subject to’ audit opinions and disclaimers of opinions affect stock prices. The results indicate that many firms experience negative abnormal performance prior to the release of qualified opinions, and that the magnitude of prior abnormal performance differs across types of qualifications. However, there is little evidence of a stock price effect when qualifications are disclosed publicly. It is difficult to construct powerful tests of the announcement effect of a qualified opinion for three reasons. First, the announcement date of the qualification is not easily identified. Second, measuring the unanticipated component of the announcement requires a model of market expectations. Third, controls must be employed for concurrent disclosures. The problems concerning event date identification have ramifications for other accounting event studies, particularly studies of disclosures typically contained in the annual report or 10-K.     

Market skewness risk and the cross section of stock returns

The cross section of stock returns has substantial exposure to risk captured by higher moments of market returns. We estimate these moments from daily Standard & Poor's 500 index option data. The resulting time series of factors are genuinely conditional and forward-looking. Stocks with high exposure to innovations in implied market skewness exhibit low returns on average. The results are robust to various permutations of the empirical setup. The market skewness risk premium is statistically and economically significant and cannot be explained by other common risk factors such as the market excess return or the size, book-to-market, momentum, and market volatility factors, or by firm characteristics.     

Reverse stock splits and earnings performance

This paper presents evidence that reverse stock splits are preceded by significantly poorer earnings performance for splitting firms compared to a sample of matched control firms. Interestingly, the overall earnings-returns relationship becomes significantly stronger following the reverse stock split. I interpret this as evidence that reverse splits communicate to market participants that sub-par earnings performance before the split is not transitory and that it is expected to persist in the future. Together, the evidence in this paper provides an explanation as to why reverse splits, which are employed for reasons that are seemingly beneficial to shareholders, are assessed negatively, on balance, by market participants.     

Changes in earnings announcement tone and insider sales

The evidence from prior literature suggests that insider trading is related to firms' reported financial results and disclosure choices. I contribute to the literature by examining the association between narrative disclosure in earnings announcements and insider trading. Specifically, I hypothesize and find a positive association between changes in the optimistic tone of earnings announcements and CEOs' subsequent equity sales. In addition, I hypothesize and find that this relation is mitigated by the Sarbanes–Oxley Act and litigation risk. CEOs' financial gain from selling equity after more optimistic earnings announcements is small relative to their total compensation.     

The role of disaggregation of earnings in stock valuation and earnings forecasting

This paper compares and contrasts two accounting information systems, the aggregate earnings system and the disaggregated cash flow/accrual system, examining their relative performance in stock valuation and in forecasting of earnings. It finds, in general, that the forecasts of earnings and predicted market values from the cash flow and accrual system have smaller forecasting errors than those from the aggregate earnings system. The adjusted R-squareds from the disaggregated system are in the main higher than those from the aggregated system when considering the explanatory power of the model-predicted values. The results also show that the cash flow and accrual system forecasts dominate the aggregate earnings system forecasts in a large majority of industries.     

Multinationals and stock return comovement

We find that when a U.S. domestic firm becomes a multinational (MNC), its returns comove more with those of existing multinational firms and less with those of purely domestic firms in the following year. This result is robust to a propensity score matching method and an exogenous shock. Turnover comovement and changes in mutual funds' holdings of these MNC initiators further indicate that investors prefer multinationals as a style investment. Moreover, MNC initiators with larger foreign sales experience larger shifts in return comovement. Finally, the effect of MNC initiation on return comovement is relatively weaker for 2000–2016 than for 1979–1997.     

Commonality in the time-variation of stock–stock and stock–bond return comovements

We jointly investigate time-varying comovements between stock returns across countries and between long-term government bond and stock returns within countries. Our focus is on how daily return comovements vary with stock uncertainty, as measured by the implied volatility (IV) from equity index options. Cross-country stock return comovements tend to be stronger (weaker) following high (low) IV days and on days with large (small) changes in IV. Stock–bond return comovements tend to be substantially positive (negative) following low (high) IV days and on days with small (large) changes in IV. A regime-switching analysis also indicates a striking temporal commonality in the stock–stock and stock–bond comovement variations. Our findings bear on understanding the influence of time-varying uncertainty on price formation and the diversification benefits of stock–bond and cross-country stock holdings.     

Analyst coverage and the idiosyncratic skewness effect in the Taiwan stock market

In this study, we investigate the effect of analyst coverage on the idiosyncratic skewness (IS) anomaly. We adopt the ordinary least square method with the corresponding standard errors that are heteroskedasticity consistent and clustered by firm. Our results show that the IS anomaly exists in the Taiwanese stock market, and analyst coverage mitigates it. Moreover, we use one exogenous shock on analysts due to the mergers and closures of brokerages to address the endogenous concern, and to confirm that analyst coverage reduces the IS anomaly. Specifically, the buy and upgrade recommendations of analysts mitigate the negative IS spreads, but their sell and downgrade recommendations aggravate those spreads. Further, we use a quasi-natural experiment on short-sale constraints in the Taiwanese stock market and find that the effects of analysts' recommendations on the negative IS spreads are not subsumed by those constraints.     

Inflation,earnings forecasts,and post-earnings announcement drift

We examine whether financial analysts fully incorporate expected inflation in their earnings forecasts for individual stocks. We find that expected inflation proxies, such as lagged inflation and inflation forecasts from the Michigan Survey of Consumers, predict the future earnings change of a portfolio long in high inflation exposure firms and short in low or negative inflation exposure firms, but analysts do not fully adjust for this relation. Analysts’ earnings forecast errors can be predicted using expected inflation proxies, and these systematic forecast errors are related to future stock returns. Overall, our evidence is consistent with the Chordia and Shivakumar (J Account Res 43(4):521–556, 2005) hypothesis that the post-earnings announcement drift is related to investor underestimation of the impact of expected inflation on future earnings change.     

Portfolio selection and skewness: Evidence from international stock markets

This paper finds that the returns of the world's 14 major stock markets are not normally distributed, and that the correlation matrix of these stock markets was stable during the January 1988–December 1993 time period. Polynomial goal programming, in which investor preferences for skewness can be incorporated, is utilized to determine the optimal portfolio consisting of the choices of 14 international stock indexes. The empirical findings suggest that the incorporation of skewness into an investor's portfolio decision causes a major change in the construction of the optimal portfolio. The evidence also indicate that investors trade expected return of the portfolio for skewness.     

Credit derivatives and stock return synchronicity

The role of credit default swaps (CDS) in the 2008 financial crisis has been widely debated among regulators, investors, and researchers. While CDS were blamed for destabilizing the financial system, they remain effective tools for hedging credit risk, especially for major banks, and produce positive informational externalities to market participants. This paper examines whether the introduction of CDS enhances the amount of firm-specific information impounded in stock prices. We use stock return synchronicity to measure the amount of firm-specific information reflected in stock prices, with more firm-specific information being associated with a lower level of synchronicity. We find that a firm’s stock return synchronicity decreases after the commencement of CDS trading. This finding is robust to different model specifications, synchronicity measures, and endogeneity controlling methodologies. Furthermore, the decrease in stock return synchronicity is more pronounced for CDS firms with higher credit risk. Overall, our evidence supports the positive role of CDS in improving informativeness of stock prices.     

Idiosyncratic skewness and cross-section of stock returns: Evidence from Taiwan

In this study, we examine whether idiosyncratic skewness (IS) affects the returns of the Taiwan stock market. We find that speculative retail investors prefer positive skewness in stocks that leads them to overprice these stocks. As a result, the IS, that reflects gambling, has a negative relation with future returns. Gambling preferences vary with time, mainly occur during recessions and down markets. Moreover, the negative IS-return relation exists only among firms with prior capital gains. We use a difference-in-difference (DID) framework to mitigate the endogeneity concern and find that this IS effect is more significant among stocks with lower arbitrage limits. The IS effect remains significant even after controlling for the IS risk factor. Overall, the IS effect cannot be explained by either arbitrage limits or risk exposure.