More than meets the eye: On the relationship between skewness and expected returns

Abstract

I investigate the relationship between skewness and expected stock returns. I find that this relationship is not lineal, as previously established, and its sign varies. Applying a methodology that estimates breakpoints in the relationship between variables results in two breakpoints, delimiting three zones. Returns are decreasing in skewness, but only for mid-skewness stocks. For low- and high-skewness stocks, the relationship is positive. An explanation of these findings is that investors who seek stocks with lottery-like characteristics such as high skewness generate the observed negative relationship in the mid-skewness zone, whereas more rational investors prevail in the other zones.