Asset Pricing with Return Asymmetries: Theory and Tests

Abstract

I derive an equilibrium asset pricing model incorporating both systematic and idiosyncratic return asymmetries, and show their respective impact on expected returns. With systematic return asymmetry, investors allocate their wealth between the risk-free security, the market portfolio, and a factor which overweights assets with high systematic asymmetry. Investors who prefer positive asymmetry remain underdiversified from a mean-variance perspective to preserve skewness in their portfolio, and idiosyncratic asymmetry therefore is priced in equilibrium. I find that a systematic asymmetry factor and a factor capturing idiosyncratic asymmetry help explain the cross-sectional variation of expected returns across U.S. equities, international equity markets, government bonds, currencies, and commodities. My results offer a risk-based explanation of expected returns that contributes to our understanding of asset pricing across multiple markets.