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Coskewness Risk Decomposition, Covariation Risk, and Intertemporal Asset Pricing

Published online by Cambridge University Press:  21 December 2018

Petko S. Kalev ,
Konark Saxena  and
Leon Zolotoy
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Abstract

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We develop an intertemporal asset pricing model where cash-flow news, discount-rate news, and their second moments are priced by the market. This model generalizes the market-return decomposition framework, showing that intertemporal considerations imply a decomposition of squared market returns (coskewness risk). Our model accounts for 68% of the return variation across portfolios sorted by size, book-to-market ratio, momentum, investment, and profitability for a modern U.S. sample period. Further, our findings highlight the importance of covariation risk, that is, the risk of simultaneous unfavorable shocks to cash flows and discount rates, in understanding equity risk premia.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 54 , Issue 1 , February 2019 , pp. 335 - 368
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

Footnotes

1

We thank Henk Berkman, Tony Berrada, Graham Bornholt, John Campbell, Jennifer Conrad (the editor), Thomas Cosimano, Robert Dittmar (the referee), Jack Favilukis, Stefano Giglio, Bruce Grundy, Ron Masulis, Pavel Savor, Tom Smith, Erik Theissen, Alireza Tourani-Rad, Terry Walter, Xiaolu Wang, and seminar participants at the University of Auckland, the University of British Columbia, the University of Geneva, École Supérieure des Sciences Économiques et Commerciales (ESSEC) Business School, Auckland University of Technology, Griffith University, Royal Melbourne Institute of Technology (RMIT) University, the University of Melbourne, the University of New South Wales, the University of Queensland, the 2015 Centre for Applied Financial Studies Annual Finance Research Colloquium, the Auckland Finance Meeting, the Bachelier Finance Society World Congress in Brussels, and the China International Conference in Finance in Shenzhen for their helpful comments. We are grateful to Kenneth French for making his Web site data available for use in this study. The usual caveats apply.

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