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Aggregation of preferences for skewed asset returns
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Chabi-Yo, Fousseni, Leisen, Dietmar P.J. and Renault, Eric (2014) Aggregation of preferences for skewed asset returns. Journal of Economic Theory, 154 . pp. 453-489. doi:10.1016/j.jet.2014.09.020 ISSN 0022-0531.
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Official URL: http://dx.doi.org/10.1016/j.jet.2014.09.020
Abstract
This paper characterizes the equilibrium demand and risk premiums in the presence of skewness risk. We extend the classical mean-variance two-fund separation theorem to a three-fund separation theorem. The additional fund is the skewness portfolio, i.e. a portfolio that gives the optimal hedge of the squared market return; it contributes to the skewness risk premium through co-variation with the squared market return and supports a stochastic discount factor that is quadratic in the market return. When the skewness portfolio does not replicate the squared market return, a tracking error appears; this tracking error contributes to risk premiums through kurtosis and pentosis risk if and only if preferences for skewness are heterogeneous. In addition to the common powers of market returns, this tracking error shows up in stochastic discount factors as priced factors that are products of the tracking error and market returns.
Item Type: | Journal Article | ||||||||
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Divisions: | Faculty of Social Sciences > Economics | ||||||||
Journal or Publication Title: | Journal of Economic Theory | ||||||||
Publisher: | Elsevier | ||||||||
ISSN: | 0022-0531 | ||||||||
Official Date: | November 2014 | ||||||||
Dates: |
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Volume: | 154 | ||||||||
Page Range: | pp. 453-489 | ||||||||
DOI: | 10.1016/j.jet.2014.09.020 | ||||||||
Status: | Peer Reviewed | ||||||||
Publication Status: | Published | ||||||||
Access rights to Published version: | Restricted or Subscription Access |
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