The Next Microsoft? Skewness, Idiosyncratic Volatility, and Expected Returns

53 Pages Posted: 12 Mar 2007

See all articles by Nishad Kapadia

Nishad Kapadia

Tulane University - Finance & Economics

Date Written: November 2006

Abstract

This paper analyzes the low subsequent returns of stocks with high idiosyncratic volatility, documented by prior research. There is substantial time-series co-variation between stocks with high idiosyncratic risk. I examine an alternative measure of aggregate skewness, the cross-sectional skewness of all firms at a given point in time. Cross-sectional skewness helps explain both the common time-variation and the premium associated with firms with high idiosyncratic volatility. Sensitivity to cross-sectional skewness is also related to the underperformance of Initial Public Offerings (IPOs) and small growth stocks. IPOs only underperform if they list in times of high cross-sectional skewness. These results imply that the low returns to IPOs, small growth stocks and highly volatile stocks are a result of a preference for skewness. Finally, proxies for technological change, such as lagged patent grant growth, predict future cross-sectional skewness. This suggests an economic interpretation of cross-sectional skewness as the result of changes in industry structure brought about by shocks such as significant technological change.

Keywords: Idiosyncratic risk, Skewness, Initial public offerings, Factor models

JEL Classification: G11

Suggested Citation

Kapadia, Nishad, The Next Microsoft? Skewness, Idiosyncratic Volatility, and Expected Returns (November 2006). Available at SSRN: https://ssrn.com/abstract=970120 or http://dx.doi.org/10.2139/ssrn.970120

Nishad Kapadia (Contact Author)

Tulane University - Finance & Economics ( email )

A.B. Freeman School of Business
7 McAlister Drive
New Orleans, LA 70118
United States
504-314-7454 (Phone)

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