Asymmetric Correlation as an Explanation for the Effect of Asset Skewness on Equity Returns

• DOI: http://doi.org/10.1111/ajfs.12188
• Date: 01 October 2017
• Author: Y. Peter Chung,Thomas S. Kim
• Published date: 01 October 2017

Asymmetric Correlation as an Explanation

for the Effect of Asset Skewness on Equity

Returns*

Y. Peter Chung**

A. Gary Anderson Graduate School of Management, University of California, United States

Thomas S. Kim

Collins College of Business, University of Tulsa, United States

Received 4 October 2016; Accepted 5 March 2017

Abstract

Assets with asymmetric correlation tend to cause portfolios to have negative skewness. We

develop measures of asymmetric correlation based on portfolio skewness. We find that asym-

metric correlation is better measured with the skewness of smaller portfolios. The skewness

of individual-stock returns has the most significant and consistent explanatory power for

stock returns, indicating that asymmetric correlation is generated at the asset level of individ-

ual firms.

Keywords Asymmetric correlation; Skewness; Fama–French factors; Suppressor variables

JEL Classification: G12

1. Introduction

Fama and French (1992, 1993) show that size and book-to-market-equity can

explain stock returns [see also Keim (1983) and Graham and Dodd (1934)]. How-

ever, since size and book-to-market alone have little economic basis to act as risk

factors, researchers have tried to explain size and book-to-market with other risk

factors. Chan and Chen (1991) find evidence that size is a proxy for financial dis-

tress. Kapadia (2011) argues that distress risk is the source of both Fama–French

factors. Jegadeesh and Titman (1993) find momentum helps explain asset returns.

*Chung and Kim appreciate financial support from the A. Gary Anderson Graduate School

of Management. They are grateful for comments from an anonymous referee, Kwangwoo

Park (the editor), and participants at the 2016 Annual Conference on Asia-Pacific Financial

Markets (CAFM) in Seoul.

**Corresponding author: Y. Peter Chung, University of California, 146 Anderson Hall, River-

side, CA 92521, USA. Tel: +1-951-827-3906, Fax: +1-951-827-3970, email: peter.chung@

ucr.edu.

Asia-Pacific Journal of Financial Studies (2017) 46, 686–699 doi:10.1111/ajfs.12188

686 ©2017 Korean Securities Association