Tail-Risk Skewness and the Quality of Risk Premia

Summary

The paper examines how excess returns across risk-premium strategies relate to asymmetric tail risk. It introduces a new definition of skewness and reports that risk premia are strongly associated with tail-risk skewness, while showing little relationship with volatility. Across equity, Fama-French, foreign-exchange carry, short-volatility, bond, and credit strategies, it finds an approximately linear relationship between Sharpe ratios and negative skewness.

Trend following stands out: the authors report positive skewness alongside positive excess returns, with value and low-volatility strategies showing a weaker version of this pattern. They interpret these cases as possible market anomalies rather than compensation for bearing risk, and propose an objective criterion for judging risk-premium portfolios. The supplied summary does not describe the underlying datasets, estimation choices, uncertainty tests, or the criterion's exact construction. The findings therefore suggest a framework for comparing strategies, but do not by themselves establish that the apparent exceptions will persist.

Key ideas

• The paper links risk-premium returns more strongly to tail-risk skewness than to volatility.
• It proposes a new definition of skewness and reports an approximately linear relationship between Sharpe ratios and negative skewness.
• Trend following is reported to have positive skewness and positive excess returns.
• Value and low-volatility strategies show a similar pattern, though less strongly.
• The authors propose using these results to assess the quality of risk-premium portfolios.

Tags

# Risk Premia: Asymmetric Tail Risks and Excess Returns


# Risk Premia: Asymmetric Tail Risks and Excess Returns









We present extensive evidence that ``risk premium'' is strongly correlated with tail-risk skewness but very little with volatility. We introduce a new, intuitive definition of skewness and elicit an approximately linear relation between the Sharpe ratio of various risk premium strategies (Equity, Fama-French, FX Carry, Short Vol, Bonds, Credit) and their negative skewness. We find a clear exception to this rule: trend following has both positive skewness and positive excess returns. This is also true, albeit less markedly, of the Fama-French ``Value'' factor and of the ``Low Volatility'' strategy. This suggests that some strategies are not risk premia but genuine market anomalies. Based on our results, we propose an objective criterion to assess the quality of a risk-premium portfolio.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.