Time-Varying Risk Attitude and Conditional Skewness

Much literature finds that the skewness in the return distribution is negatively correlated with the risk premium coefficient, and speculation is the reason for the skewness in the return distribution. As further research, this paper, first taking up the time-varying property of the risk premium coefficient, proposes a GARCH-M model with a time-varying coefficient of the risk premium for an empirical study of the correlation between the conditional skewness in the return distribution and the time-varying risk attitude. The empirical study indicates that the coefficient of the risk premium varies with the time, and even in a mature market the conditional skewness in the return distribution is negatively correlated with the time-varying coefficient of the risk premium

Time-Varying Risk Attitude and Conditional Skewness

Much literature finds that the skewness in the return distribution is negatively correlated with the risk premium coefficient, and speculation is the reason for the skewness in the return distribution. As further research, this paper, first taking up the time-varying property of the risk premium coefficient, proposes a GARCH-M model with a time-varying coefficient of the risk premium for an empirical study of the correlation between the conditional skewness in the return distribution and the time-varying risk attitude. The empirical study indicates that the coefficient of the risk premium varies with the time, and even in a mature market the conditional skewness in the return distribution is negatively correlated with the time-varying coefficient of the risk premium

High-Order Consumption Moments and Asset Pricing

To assess the potential of incomplete consumption insurance for explaining the equity premium and the risk-free rate of return, we use a Taylor series expansion of the individual's marginal utility of consumption around the conditional expectation of consumption and derive an approximate equilibrium model for expected returns. In this model, the priced risk factors are the cross-moments of return with the moments of the cross-sectional distribution of individual consumption and the coefficients of the risk factors are determined by the derivatives of the utility function. Using this approach allows to avoid an ad hoc specification of preferences and to consider a general class of utility functions when addressing the question of the effect of a particular moment of the cross-sectional distribution of individual consumption on the expected equity premium and risk-free interest rate. We demonstrate that if consumers exhibit decreasing and convex absolute prudence, then the cross-sectional mean and skewness of individual consumption help explain the equity premium if their cross-moments with the excess market portfolio return are positive, while the cross-sectional variance and kurtosis always lower the equity premium explained by the model. The empirical investigation uses the data on the monthly household consumption of nondurables and services, reconstructed from the Consumer Expenditure Survey database. The Hansen-Jagannathan volatility bound analysis, calibration, and GMM analysis results show that under the CRRA preferences, the model can reproduce the observed equity premium and risk-free rate with economically plausible values of the relative risk aversion coefficient (between 0.6 and 1.6) and the time discount factor when the cross-sectional skewness of individual consumption, combined with the cross-sectional mean and variance, is taken into accountequity premium puzzle, heterogeneous consumers, incomplete consumption insurance, risk-free rate puzzle.

Risk premium: insights over the threshold

The aim of this paper is twofold: First to test the adequacy of Pareto distributions to describe the tail of financial returns in emerging and developed markets, and second to study the possible correlation between stock market indices observed returns and return's extreme distributional characteristics measured by Value at Risk and Expected Shortfall. We test the empirical model using daily data from 41 countries, in the period from 1995 to 2005. The findings support the adequacy of Pareto distributions and the use of a log linear regression estimation of their parameters, as an alternative for the usually employed Hill's estimator. We also report a significant relationship between extreme distributional characteristics and observed returns, especially for developed countries

Test of Multi-moment Capital Asset Pricing Model: Evidence from Karachi Stock Exchange

This study examines the Capital Asset Pricing Model of Sharpe (1964) Lintner (1965) and Black (1972) as the benchmark model in the asset pricing theory. The empirical findings indicate that the Sharpe-Lintner-Black CAPM inadequately, particularly the explains Pakistan’s equity market economically and statistically significant role of market risk for the determination of expected returns. Instead of identifying more risk factors, a detailed analysis of a single risk factor is undertaken. We have concentrated on two main extensions of the standard CAPM model. First, the standard model is extended by taking higher moments into account. Second, the risk factors are allowed to vary over time in the autoregressive process. The result of unconditional non-linear generalisation of the standard model reveals that in the higher-moment CAPM model the investors are rewarded for co-skewness risk. However, the test provides marginal support for rewards of the co-kurtosis risk. Finally, the empirical usefulness of conditional higher moments in explaining the cross-section of asset return is investigated. The results indicate that the conditional co-skewness is an important determinant of asset pricing, and the asset pricing relationship varies through time. The conditional covariance and the conditional co-kurtosis explain the asset price relationship in a limited way. It is concluded that Kraus and Litzenberger (1976) attempts to develop a modified form of the Sharpe- Lintner-Black CAPM and is more successful with KSE data.Covariance, Co-skewness, Co-kurtosis, Non-normal Return Distribution, Capital Asset Pricing Model, Time-varying Moments.

SHORT-TERM OPTIONS WITH STOCHASTIC VOLATILITY: ESTIMATION AND EMPIRICAL PERFORMANCE

This paper examines the stochastic volatility model suggested by Heston (1993). We employ a time-series approach to estimate the model and we discuss the potential effects of time-varying skewness and kurtosis on the performance of the model. In particular, it is found that the model tends to overprice out-of-the-money calls and underprice in-the-money calls. It is also found that the daily volatility risk premium presents a quite volatile behavior over time; however, our evidence suggests that the volatility risk premium has a negligible impact on the pricing performance of Heston´s model.Stochastic, Volatility, Skewness, Kurtosis, Pricing.

RISK PREMIUM: INSIGHTS OVER THE THRESHOLD

The aim of this paper is twofold: First to test the adequacy of Pareto distributions to describe the tail of financial returns in emerging and developed markets, and second to study the possible correlation between stock market indices observed returns and return’s extreme distributional characteristics measured by Value at Risk and Expected Shortfall. We test the empirical model using daily data from 41 countries, in the period from 1995 to 2005. The findings support the adequacy of Pareto distributions and the use of a log linear regression estimation of their parameters, as an alternative for the usually employed Hill’s estimator. We also report a significant relationship between extreme distributional characteristics and observed returns, especially for developed countries.