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Expected Skewness and Momentum: Exploring the Interplay

Last Updated on 10 February, 2024 by Rejaul Karim

Expected Skewness and Momentum” is an insightful research paper penned by Heiko Jacobs of the University of Duisburg-Essen, Campus Essen, Tobias Regele of Allianz SE – Allianz Global Investors Europe, and Martin Weber of the University of Mannheim – Department of Banking and Finance.

This scholarly work meticulously explores the nuanced interplay between expected skewness and momentum in the cross-section of financial data, underpinned by time-series investigations of Daniel and Moskowitz (2016). The researchers observe a noteworthy trend: the alpha of momentum, depending on whether it’s enhanced or reduced by skewness, expands or shrinks to approximately twice or half the size of the conventional alpha, respectively.

The occurrence is predominantly influenced by the short leg. A diverse set of methods such as portfolio sorts, Fama-MacBeth regressions, and analysis of market reactions to earnings announcements, convincingly suggest that expected skewness is a major determinant of momentum. Given the simplicity of the methodology, the significant economic implications, its prevalence among large stocks, and the effective risk management, the findings pose a compelling challenge to the efficient market hypothesis.

Abstract Of Paper

Motivated by the time-series insights of Daniel and Moskowitz (2016), we investigate the link between expected skewness and momentum in the cross-section. The alpha of skewness-enhanced (-weakened) momentum is about twice (half) as large as the traditional alpha. These findings are driven by the short leg. Portfolio sorts, Fama-MacBeth regressions, and the market reaction to earnings announcements suggest that expected skewness is an important determinant of momentum. Due to the simplicity of the approach, its economic magnitude, its existence among large stocks, and the success of risk management, the results are difficult to reconcile with the efficient market hypothesis.

Original paper – Download PDF

Here you can download the PDF and original paper of Expected Skewness and Momentum.

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Author

Heiko Jacobs
University of Duisburg-Essen, Campus Essen

Tobias Regele
Allianz SE – Allianz Global Investors Europe

Martin Weber
University of Mannheim – Department of Banking and Finance

Conclusion

This study remarkably finds that the alpha of momentum, influenced vastly by skewness, is either double or half of the traditional alpha – a phenomena primarily driven by the short leg. Observations from portfolio sorts, Fama-MacBeth regressions, and market reactions to earnings announcements underscore the significance of expected skewness on momentum.

Given the approach’s simplicity, its economic size, relevance in large stocks, and successful risk management, these findings present a challenge to the efficient market hypothesis, making expected skewness a crucial aspect of momentum.

Related Reading:

Investor Sentiment Dynamics, the Cross-Section of Stock Returns and the MAX Effect

Stock Return Predictability and Seasonality

FAQ

What is the impact of expected skewness on the alpha of momentum?

The research suggests that expected skewness significantly influences the alpha of momentum. Skewness-enhanced momentum has an alpha approximately twice as large as the traditional alpha, while skewness-weakened momentum has an alpha roughly half the size of the conventional alpha. This phenomenon is particularly noticeable in the short leg.

How was the link between expected skewness and momentum investigated in the study?

The study employed various methods, including portfolio sorts, Fama-MacBeth regressions, and an analysis of market reactions to earnings announcements, to comprehensively investigate the relationship between expected skewness and momentum in the cross-section of financial data.

In what way do the findings challenge the efficient market hypothesis?

The simplicity of the approach, combined with the economic significance of the results, challenges the efficient market hypothesis. The observed impact of expected skewness on momentum, its prevalence among large stocks, and its effectiveness in risk management raise questions about the market’s efficiency in incorporating such information into stock prices.

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