N° 19-50: Low Risk Anomalies?

This paper shows that low risk anomalies in the CAPM and in traditional factor models arise when investors require compensation for coskewness risk. Empirically, we find that option-implied ex-ante skewness is strongly related to ex-post residual coskewness, which allows us to construct coskewness factor mimicking portfolios. Controlling for skewness renders the alphas of betting-against-beta and -volatility insignificant. We also show that the returns of beta- and volatility-sorted portfolios are largely driven by a single principal component, which is in turn largely explained by skewness.