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Low Risk Anomalies?

Last Updated on 10 February, 2024 by Rejaul Karim

Low Risk Anomalies?” is a forthcoming paper in the Journal of Finance by Schneider, Wagner, and Zechner, who explore the occurrence of low-risk anomalies in the CAPM and traditional factor models.

The authors discover these anomalies are more likely to emerge when investors require recompense for coskewness risk. Their analysis uncovers a strong link between option-implied ex-ante skewness and ex-post residual coskewness, providing grounds for constructing coskewness factor mimicking portfolios.

The paper further reveals that controlling for skewness negates the alphas of betting-against-beta and -volatility. It also showcases that the returns of beta- and volatility-sorted portfolios are majorly driven by a single principal component, largely explained by skewness.

Abstract Of Paper

This paper shows that low risk anomalies in the CAPM and in traditional factor models arise when investors require compensation for coskewness risk. Empirically, we find that option-implied ex-ante skewness is strongly related to ex-post residual coskewness, which allows us to construct coskewness factor mimicking portfolios. Controlling for skewness renders the alphas of betting-against-beta and -volatility insignificant. We also show that the returns of beta- and volatility-sorted portfolios are largely driven by a single principal component, which is in turn largely explained by skewness.

Original paper – Download PDF

Here you can download the PDF and original paper of ‘Low Risk Anomalies?

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Author

Paul Schneider
University of Lugano – Institute of Finance; Swiss Finance Institute

Christian Wagner
WU Vienna University of Economics and Business; Vienna Graduate School of Finance (VGSF)

Josef Zechner
Vienna University of Economics and Business

Conclusion

To conclude, “Low Risk Anomalies?” provides significant insight into the emergence of low-risk anomalies in the CAPM and conventional factor models, arguing that these arrive when investors demand compensation for coskewness risk.

The investigation reveals a potent association between option-implied ex-ante skewness and ex-post residual coskewness, paving the way for coskewness factor mimicking portfolios. Importantly, the study shows that skewness control eradicates the alphas of betting-against-beta and -volatility.

Furthermore, the returns of beta- and volatility-sorted portfolios are found primarily driven by a solitary principal component, predominantly elucidated by skewness. These findings illuminate the interplay of skewness and coskewness in shaping low-risk anomalies, potentially refining our understanding of risk management strategies.

Related Reading:

The Betting Against Beta Anomaly: Fact or Fiction?

Buffett’s Alpha

FAQ

What is the main focus of the forthcoming paper “Low Risk Anomalies?” by Schneider, Wagner, and Zechner?

The main focus of the paper is on investigating the occurrence of low-risk anomalies in the Capital Asset Pricing Model (CAPM) and traditional factor models. The authors aim to understand the conditions under which low-risk anomalies emerge and provide empirical evidence supporting their findings.

What do the authors discover about the emergence of low-risk anomalies in the CAPM and traditional factor models?

The authors discover that low-risk anomalies in the CAPM and traditional factor models are more likely to arise when investors demand compensation for coskewness risk. Coskewness risk refers to the risk associated with the skewness of returns, and the paper explores the relationship between option-implied ex-ante skewness and ex-post residual coskewness.

How do option-implied ex-ante skewness and ex-post residual coskewness relate to each other in the paper’s analysis?

The paper finds a strong relationship between option-implied ex-ante skewness and ex-post residual coskewness. This empirical link allows the authors to construct coskewness factor mimicking portfolios. In other words, the study leverages option-implied skewness information to create portfolios that mimic the coskewness risk.

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