Skewness as a Factor

Analysing Punchy Stocks

June 2018. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Skewness is a feature of stocks with high firm-risks
  • Stocks with positive or negative skewness outperform the market
  • Can partially be explained by the Size factor

INTRODUCTION

Many investors started their investment career at an early age, typically buying a stock that showed an enticing performance chart, was featured somewhere or recommended by a family member. Moving to a professional investment career often required a change in mentality by progressing from returns to risk-adjusted returns. Investors can continue this education by adding skewness and kurtosis as further layers of analysing potential investments; however, this often becomes challenging as these are somewhat more abstract concepts. Both provide insights into the distribution of returns, which unlike often assumed in financial theory, are not normally distributed.

Investors rank stocks by returns (Momentum) and volatility (Low Volatility) and could also use skewness and kurtosis as sorting variables (read Momentum Factor: Intra vs Cross-Sector). We will explore using skewness as a measure for ranking stocks, although we have no theory or expectation that this will result in anything but random returns, so this research note should be considered only for satisfying intellectual curiosity.

METHODOLOGY

We focus on the US stock market and measure the skewness of stocks over the last 12 months. Portfolios are created by selecting the top 10% of most skewed stocks, which results in a portfolio with the most positively and a portfolio with the most negatively skewed stocks. We also construct beta-neutral factor portfolios by buying the portfolios of skewed stocks and shorting the index. Only stocks with a market capitalisation of larger than $1 billion are included. Portfolios are rebalanced monthly and each transaction occurs costs of 10 basis points.

SKEWNESS OF THE S&P 500 

In advance of the analysis of skewness on single stock level it is interesting to highlight the skewness of the entire stock market. Positive skewness describes a return distribution where frequent small losses and a few extreme gains are common while negative skewness highlights frequent small g