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Skewness Underlies Stock Market Anomalies?

Posted in Animal Spirits, Equity Premium

Does retail investor preference for stocks with skewed return distributions explain stock return anomalies? In their April 2018 paper entitled "Skewness Preference and Market Anomalies", Alok Kumar, Mehrshad Motahari and Richard Taffler investigate whether investor preference for positively-skewed payoffs is a common driver of mispricing as indicated by a wide range of market anomalies. They each month measure the skewness of each stock via four metrics: (1) jackpot probability (probability of a return greater than 100% the next 12 months); (2) lottery index (with high relating to low price, high volatility and high skewness; (3) maximum daily return the past month; and, (4) expected idiosyncratic skewness. They also each month measure aggregate mispricing of each stock as its average decile rank when sorting all stocks into tenths on each of 11 widely used anomaly variables. They assess the role of retail investors based on 1991-1996 portfolio holdings data from a large U.S. discount broker. Using a broad sample of U.S. common stocks (excluding financial stocks, firms with negative book value and stocks priced less than $1) during January 1963 through December 2015, they find that:

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