The roles of systematic skewness and systematic kurtosis in asset pricing
Creators: name: Doan, Minh Phuong
Publisher: name: RMIT University
Year: 2024

description: The role of higher moments of a return distribution has become increasingly important in the literature mainly because traditional measures of risk based on the mean-variance framework have failed to fully characterise return behaviour (Samuelson 1970; Campbell and Hentschel 1992; Kirchler and Huber 2007). Given that the empirical stock return distribution is observed to be both asymmetric and leptokurtic, this study examines the importance of skewness and kurtosis in asset pricing in the context of the Australian market from 1992 to 2009. <br>The study focuses on systematic measures of skewness and kurtosis to investigate the importance of skewness and kurtosis in asset pricing. The study investigates skewness and kurtosis through three different aspects. Firstly, the study examines whether asset returns are mean-variance-skewness-kurtosis efficient rather than conventionally mean-variance efficient. Secondly, the study investigates whether skewness and kurtosis are important pricing factors for asset returns. Thirdly, the study examines whether systematic skewness and systematic kurtosis can effectively capture the market risk asymmetry between bull and bear markets. <br>To investigate the first aspect, the study conducts empirical tests of the capital asset pricing model (CAPM) within the multivariate linear regression framework. Within this framework, the study firmly rejects the hypothesis of mean-variance efficiency of asset returns and shows evidence that the market beta is not sufficient to explain asset returns. The study then investigates whether asset returns are mean-variance-skewness-kurtosis efficient. The analysis is carried out using a generalised multivariate method and a bootstrap method. The study finds that Australian asset returns are generally mean-variance-skewness-kurtosis efficient in the four periods of 1992–1996, 1997–2001, 2002–2006 and 1992–2006. This provides convincing evidence that the four-moment model developed in this study has advantages in explaining patterns of asset returns over the two-moment model.<br>The second aspect is investigated using both time-series and cross-sectional approaches. The study uses the Fama and French (1992) methodology to examine time-series returns while the Fama and MacBeth (1973) two-pass methodology is used to examine asset returns in cross-section. The analysis using these procedures strongly suggests that systematic skewness and systematic kurtosis are important pricing factors for asset returns. Interestingly, the study finds that when systematic skewness and kurtosis are added to the CAPM model, they appear to be the dominant explanatory variables and make the market factor insignificant.<br>The final aspect is investigated in the context of the two-moment dual-beta model proposed by Bharadwai and Brooks (1993) and the four-moment dual-beta model developed in this study. Within the two-moment framework, the study finds that market risk asymmetry is significant in the Australian market. However, when systematic skewness and systematic kurtosis are added to the CAPM, these factors can capture the market risk asymmetry effectively. Finally, the study concludes that the four-moment model has advantages over the two-moment dual-beta model proposed by Bharadwai and Brooks (1993) because it provides an effective method to capture the asymmetry in risk factor loadings without having to specify bull and bear periods.