The predictability of skewness risk premium on stock returns: Evidence from Chinese market

Skewness risk premium is the difference between realized skewness and implied skewness. This paper provides empirical evidence of the predictive power of skewness risk premium for the stock returns both from cross-sectional and time series. We find that the skewness risk premium exists in the Chinese market and is positively correlated with future index excess returns, as evidenced by both in-sample and out-of-sample analyses. From a cross-sectional perspective, we find stocks with high exposure to the skewness risk premium yield higher average excess returns. When controlling for common risk factors, the forecasting power of the skewness risk premium remains robust. In addition, this paper also examines the impact of investor sentiment and risk aversion on the predictability of skewness risk premium. We find the risk-return relation is weaker during high investor sentiment and low risk aversion.