Individual Investors, Average Skewness, and Market Returns

Jungmu Kim,Yuen Jung Park

doi:10.3390/su12208357

Abstract

Understanding individual investors’ short-term behavior toward skewness is essential for the management and investment of corporate social responsibility because the skewness-seeking behavior of individual investors, which causes a bubble in the market, makes the market as a whole more vulnerable, and it is difficult for the market to be sustainable. In the Korean stock market, we investigated whether average skewness can predict future market returns at the market level and whether the mispricing is associated with demand for the skewness of individual noise traders. Measuring the demand for skewness by the proportion of trading money of individual investors, we found that average skewness negatively predicts future market excess return when the demand for skewness is strong. The result is robust to controlling for market variance as well as other predictors. Our finding indicates that the overall market is overpriced when individual investors excessively trade to seek huge returns in spite of a small probability.

Highlights

It is well-known that individual investors exhibit strong preferences for huge positive returns in spite of a very small probability of realization [1,2,3,4]
This paper argues that when individual investors participate in the stock market more actively, the degree of under-diversification is higher, and average skewness is significantly negatively associated with expected market returns
Where Rm,t is the market excess return in month t which is measured by the value-weighted average return of all stocks minus the commercial deposit (CD) 91-day rate

Summary

Introduction

It is well-known that individual investors exhibit strong preferences for huge positive returns in spite of a very small probability of realization [1,2,3,4]. Evidence shows that they often buy stocks with high skewness or high volatility at expensive prices in order to entertain the likelihood of jackpot. A bunch of research provides evidence that most individuals hold only a few equities, and their portfolios are under-diversified with respect to idiosyncratic risks rather than well-diversified Such behavior of individual investors affects asset prices in a different way than traditional finance portfolio theories predict. Their model suggests that the cross-sectional average of idiosyncratic skewness predicts future market excess returns

Results

Discussion

Conclusion