Working Paper: NBER ID: w25113
Authors: Simon Oh; Jessica A. Wachter
Abstract: This paper evaluates skewness in the cross-section of stock returns in light of predictions from a well-known class of models. Cross-sectional skewness in monthly returns far exceeds what the standard lognormal model of returns would predict. However, skewness in long-run returns substantially understates what the lognormal model would predict. Nonstationary share dynamics imply a breakdown in the distinction between market and idiosyncratic risk in the lognormal model. We present an alternative model that matches the skewness in the data and implies stationary wealth shares. In this model, idiosyncratic risk is the primary driver of growth in the economy.
Keywords: No keywords provided
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inadequacy of lognormal model (C51) | underestimation of market risk (G17) |
| inadequacy of lognormal model (C51) | overestimation of idiosyncratic risk (D81) |
| idiosyncratic shocks (D89) | nonstationary distribution of firm sizes (D39) |
| skewness in monthly returns (C46) | misestimation of risk (D81) |
| skewness in monthly returns (C46) | inadequacy of lognormal model (C51) |
| binomial model (C25) | cross-sectional skewness (C46) |