This action might not be possible to undo. Are you sure you want to continue?

BooksAudiobooksComicsSheet Music### Categories

### Categories

### Categories

### Publishers

Scribd Selects Books

Hand-picked favorites from

our editors

our editors

Scribd Selects Audiobooks

Hand-picked favorites from

our editors

our editors

Scribd Selects Comics

Hand-picked favorites from

our editors

our editors

Scribd Selects Sheet Music

Hand-picked favorites from

our editors

our editors

Top Books

What's trending, bestsellers,

award-winners & more

award-winners & more

Top Audiobooks

What's trending, bestsellers,

award-winners & more

award-winners & more

Top Comics

What's trending, bestsellers,

award-winners & more

award-winners & more

Top Sheet Music

What's trending, bestsellers,

award-winners & more

award-winners & more

P. 1

Forecasting Stock Market Crashes|Views: 19|Likes: 0

Published by maddierogers

Journal of Financial Economics 61 (2001) 345–381

Forecasting crashes: trading volume, past returns, and conditional skewness in stock prices$

Joseph Chena, Harrison Honga, Jeremy C. Steinb,*

a b

Graduate School of Business, Stanford University, Stanford, CA 94305, USA Department of Economics, Harvard University, Cambridge, MA 02138, USA Received 6 January 2000; accepted 17 July 2000

Abstract We develop a series of cross-sectional regression speciﬁcations to forecast skewness in the daily retu

Forecasting crashes: trading volume, past returns, and conditional skewness in stock prices$

Joseph Chena, Harrison Honga, Jeremy C. Steinb,*

a b

Graduate School of Business, Stanford University, Stanford, CA 94305, USA Department of Economics, Harvard University, Cambridge, MA 02138, USA Received 6 January 2000; accepted 17 July 2000

Abstract We develop a series of cross-sectional regression speciﬁcations to forecast skewness in the daily retu

Journal of Financial Economics 61 (2001) 345–381

Forecasting crashes: trading volume, past returns, and conditional skewness in stock prices$

Joseph Chena, Harrison Honga, Jeremy C. Steinb,*

a b

Graduate School of Business, Stanford University, Stanford, CA 94305, USA Department of Economics, Harvard University, Cambridge, MA 02138, USA Received 6 January 2000; accepted 17 July 2000

Abstract We develop a series of cross-sectional regression speciﬁcations to forecast skewness in the daily retu

Forecasting crashes: trading volume, past returns, and conditional skewness in stock prices$

Joseph Chena, Harrison Honga, Jeremy C. Steinb,*

a b

Graduate School of Business, Stanford University, Stanford, CA 94305, USA Department of Economics, Harvard University, Cambridge, MA 02138, USA Received 6 January 2000; accepted 17 July 2000

Abstract We develop a series of cross-sectional regression speciﬁcations to forecast skewness in the daily retu

See more

See less

https://www.scribd.com/doc/54180994/Forecasting-Stock-Market-Crashes

08/13/2012

text

original

**Forecasting crashes: trading volume,
**

past returns, and conditional skewness in

stock prices

$

Joseph Chen

a

, Harrison Hong

a

, Jeremy C. Stein

b,

*

a

Graduate School of Business, Stanford University, Stanford, CA 94305, USA

b

Department of Economics, Harvard University, Cambridge, MA 02138, USA

Received 6 January 2000; accepted 17 July 2000

Abstract

We develop a series of cross-sectional regression speciﬁcations to forecast skewness in

the daily returns of individual stocks. Negative skewness is most pronounced in stocks

that have experienced (1) an increase in trading volume relative to trend over the prior

six months, consistent with the model of Hong and Stein (NBER Working Paper, 1999),

and (2) positive returns over the prior 36 months, which ﬁts with a number of theories,

most notably Blanchard and Watson’s (Crises in Economic and Financial Structure.

Lexington Books, Lexington, MA, 1982, pp. 295–315) rendition of stock-price bubbles.

Analogous results also obtain when we attempt to forecast the skewness of the

aggregate stock market, though our statistical power in this case is limited. r 2001

Elsevier Science S.A. All rights reserved.

JEL classiﬁcation: G12; G14

Keywords: Crashes; Trading volume; Skewness

$

We are grateful to the National Science Foundation for research support, and to John

Campbell, Kent Daniel, Ken Froot, Ravi Jagannathan, Phillipe Jorion, Chris Lamoreaux, Ken

Singleton, an anonymous referee, and seminar participants at Arizona, Arizona State, Cornell,

Harvard Business School, Northwestern, Maryland, Stanford, Texas, the UCLA Liquidity

Conference, and the NBER for helpful comments and suggestions. Thanks also to Jun Pan for

generously sharing her option-pricing software with us.

*Corresponding author.

E-mail address: jeremy stein@harvard.edu (J.C. Stein).

0304-405X/01/$ - see front matter r 2001 Elsevier Science S.A. All rights reserved.

PII: S 0 3 0 4 - 4 0 5 X( 0 1 ) 0 0 0 6 6 - 6

1. Introduction

Aggregate stock market returns are asymmetrically distributed. This

asymmetry can be measured in several ways. First, and most simply, the very

largest movements in the market are usually decreases, rather than increases –

that is, the stock market is more prone to melt down than to melt up. For

example, of the ten biggest one-day movements in the S&P 500 since 1947, nine

were declines.

1

Second, a large literature documents that market returns exhibit

negative skewness, or a closely related property, ‘‘asymmetric volatility’’ – a

tendency for volatility to go up with negative returns.

2

Finally, since the crash

of October 1987, the prices of stock index options have been strongly indicative

of a negative asymmetry in returns, with the implied volatilities of out-of-the-

money puts far exceeding those of out-of-the-money calls; this pattern has

come to be known as the ‘‘smirk’’ in index-implied volatilities. (See, e.g., Bates,

1997; Bakshi et al., 1997; and Dumas et al., 1998.)

While the existence of negative asymmetries in market returns is generally

not disputed, it is less clear what underlying economic mechanism these

asymmetries reﬂect. Perhaps the most venerable theory is based on leverage

eﬀects (Black, 1976; Christie, 1982), whereby a drop in prices raises operating

and ﬁnancial leverage, and hence the volatility of subsequent returns. However,

it appears that leverage eﬀects are not of suﬃcient quantitative importance to

explain the data (Schwert, 1989; Bekaert and Wu, 2000). This is especially true

if one is interested in asymmetries at a relatively high frequency, e.g., in daily

data. To explain these, one has to argue that intraday changes in leverage have

a large impact on volatility – that a drop in prices on Monday morning leads to

a large increase in leverage and hence in volatility by Monday afternoon, so

that overall, the return for the full day Monday is negatively skewed.

An alternative theory is based on a ‘‘volatility feedback’’ mechanism. As

developed by Pindyck (1984), French et al. (1987), Campbell and Hentschel

(1992), and others, the idea is as follows: When a large piece of good news

arrives, this signals that market volatility has increased, so the direct positive

eﬀect of the good news is partially oﬀset by an increase in the risk premium. On

the other hand, when a large piece of bad news arrives, the direct eﬀect and the

risk-premium eﬀect now go in the same direction, so the impact of the news is

ampliﬁed. While the volatility-feedback story is in some ways more attractive

1

Moreover, the one increase – of 9.10% on October 21, 1987 – was right on the heels of the

20.47% decline on October 19, and arguably represented a correction of the microstructural

distortions that arose on that chaotic day, rather than an independent price change.

2

If, in a discrete-time setting, a negative return in period t raises volatility in period t þ1 and

thereafter, returns measured over multiple periods will be negatively skewed, even if single-period

returns are not. The literature on these phenomena includes Pindyck (1984), French et al. (1987),

Campbell and Hentschel (1992), Nelson (1991), Engle and Ng (1993), Glosten et al. (1993), Braun

et al. (1995), Duﬀee (1995), Bekaert and Wu (2000), and Wu (2001).

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 346

than the leverage-eﬀects story, there are again questions as to whether it has the

quantitative kick that is needed to explain the data. The thrust of the critique,

ﬁrst articulated by Poterba and Summers (1986), is that shocks to market

volatility are for the most part very short-lived, and hence cannot be expected

to have a large impact on risk premiums.

A third explanation for asymmetries in stock market returns comes from

stochastic bubble models of the sort pioneered by Blanchard and Watson

(1982). The asymmetry here is due to the popping of the bubble – a

low-probability event that produces large negative returns.

What the leverage-eﬀects, volatility-feedback, and bubble theories all have in

common is that they can be cast in a representative-investor framework. In

contrast, a more recent explanation of return asymmetries, Hong and Stein

(1999), argues that investor heterogeneity is central to the phenomenon. The

Hong-Stein model rests on two key assumptions: (1) there are diﬀerences of

opinion among investors as to fundamental value, and (2) some – though not

all – investors face short-sales constraints. The constrained investors can be

thought of as mutual funds, whose charters typically prohibit them from taking

short positions; the unconstrained investors can be thought of as hedge funds

or other arbitrageurs.

When diﬀerences of opinion are initially large, those bearish investors who

are subject to the short-sales constraint will be forced to a corner solution, in

which they sell all of their shares and just sit out of the market. As a

consequence of being at a corner, their information is not fully incorporated

into prices. For example, if the market-clearing price is $100, and a particular

investor is sitting out, it must be that his valuation is less than $100, but one

has no way of knowing by how much – it could be $95, but it could also be

much lower, say $50.

However, if after this information is hidden, other, previously more-bullish

investors have a change of heart and bail out of the market, the originally

more-bearish group may become the marginal ‘‘support buyers’’ and hence

more will be learned about their signals. In particular, if the investor who was

sitting out at a price of $100 jumps in and buys at $95, this is good news relative

to continuing to sit on the sidelines even as the price drops further. Thus,

accumulated hidden information tends to come out during market declines,

which is another way of saying that returns are negatively skewed.

With its focus on diﬀerences of opinion, the Hong-Stein model has

distinctive empirical implications that are not shared by the representative-

investor theories. In particular, the Hong-Stein model predicts that negative

skewness in returns will be most pronounced around periods of heavy trading

volume. This is because – like in many models with diﬀerences of opinion –

trading volume proxies for the intensity of disagreement. (See Varian, 1989;

Harris and Raviv, 1993; Kandel and Pearson, 1995; and Odean, 1998a for

other models with this feature.)

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 347

When disagreement (and hence trading volume) is high, it is more likely that

bearish investors will wind up at a corner, with their information incompletely

revealed in prices. And it is precisely this hiding of information that sets the

stage for negative skewness in subsequent rounds of trade, when the arrival of

bad news to other, previously more-bullish investors can force the hidden

information to come out.

In this paper, we undertake an empirical investigation that is motivated by

this diﬀerences-of-opinion theory. We develop a series of cross-sectional

regression speciﬁcations that attempt to forecast skewness in the daily returns

to individual stocks. Thus, when we speak of ‘‘forecasting crashes’’ in the title

of the paper, we are adopting a narrow and euphemistic deﬁnition of the word

‘‘crashes,’’ associating it solely with the conditional skewness of the return

distribution; we are not in the business of forecasting negative expected returns.

This usage follows Bates (1991, 1997), who also interprets conditional skewness

– in his case, inferred from options prices – as a measure of crash expectations.

One of our key forecasting variables is the recent deviation of turnover from

its trend. For example, at the ﬁrm level, we ask whether the skewness in daily

returns measured over a given six-month period (say, July 1–December 31,

1998) can be predicted from the detrended level of turnover over the prior six-

month period (January 1–June 30, 1998). It turns out that ﬁrms that experience

larger increases in turnover relative to trend are indeed predicted to have more

negative skewness; moreover, the eﬀect of turnover is strongly statistically and

economically signiﬁcant.

In an eﬀort to isolate the eﬀects of turnover, our speciﬁcations also include a

number of control variables. These control variables can be divided into two

categories. In the ﬁrst category are those that, like detrended turnover, capture

time-varying inﬂuences on skewness. The most signiﬁcant variable in this

category is past returns. We ﬁnd that when past returns have been high,

skewness is forecasted to become more negative. The predictive power is

strongest for returns in the prior six months, but there is some ability to predict

negative skewness based on returns as far back as 36 months. In a similar vein,

glamour stocks – those with low ratios of book value to market value – are also

forecasted to have more negative skewness. (Harvey and Siddique (2000) also

examine how skewness varies with past returns and book-to-market.) These

results can be rationalized in a number of ways, but they are perhaps most

clearly suggested by models of stochastic bubbles. In the context of a bubble

model, high past returns or a low book-to-market value imply that the bubble

has been building up for a long time, so that there is a larger drop when it pops

and prices fall back to fundamentals.

The second category of variables that help to explain skewness are those that

appear to be picking up relatively ﬁxed ﬁrm characteristics. For example, it has

been documented by others (e.g., Damodaran, 1987; Harvey and Siddique,

2000) that skewness is more negative on average for large-cap ﬁrms – a pattern

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 348

that also shows up strongly in our multivariate regressions. We are not aware

of any theories that would have naturally led one to anticipate this ﬁnding.

Rather, for our purposes a variable like size is best thought of as an atheoretic

control – it is included in our regressions to help ensure that we do not

mistakenly attribute explanatory power to turnover when it is actually

proxying for some other ﬁrm characteristic. Such a control might be redundant

to the extent that detrending the turnover variable already removes ﬁrm eﬀects,

but we keep it in to be safe.

In addition to running our cross-sectional regressions with the individual-

ﬁrm data, we also experiment brieﬂy with analogous time-series regressions for

the U.S. stock market as a whole. Here, we attempt to forecast the skewness in

the daily returns to the market using detrended market turnover and past

market returns. Obviously, this pure time-series approach entails an enormous

loss in statistical power – with data going back to 1962, we have less than 70

independent observations of market skewness measured at six-month intervals

– which is why it is not the main focus of our analysis. Nevertheless, it is

comforting to note that the qualitative results from the aggregate-market

regressions closely parallel those from the cross-sectional regressions in that

high values of both detrended turnover and past returns also forecast more

negative market skewness. The coeﬃcient estimates continue to imply

economically meaningful eﬀects, although that for detrended turnover is no

longer statistically signiﬁcant.

While both the cross-sectional and time-series results for turnover are

broadly consistent with the theory we are interested in, we should stress that we

do not at this point view them as a tight test. There are several reasons why one

might wish to remain skeptical. First, beyond the eﬀects of turnover, we

document other strong inﬂuences on skewness, such as ﬁrm size, that are not

easily rationalized within the context of the Hong-Stein model, and for which

there are no other widely accepted explanations. Second, even if innovations to

trading volume proxy for the intensity of disagreement among investors, they

likely capture other factors as well – such as changes in trading costs – that we

have not adequately controlled for. Finally, and most generally, our eﬀorts to

model the determinants of conditional skewness at the ﬁrm level are really

quite exploratory in nature. Given how early it is in this game, we are naturally

reluctant to declare an unqualiﬁed victory for any one theory.

The remainder of the paper is organized as follows. In Section 2, we review

in more detail the theoretical work that motivates our empirical speciﬁcation.

In Section 3, we discuss our sample and the construction of our key variables.

In Section 4, we present our baseline cross-sectional regressions, along with a

variety of sensitivities and sample splits. In Section 5, we consider the

analogous time-series regressions, in which we attempt to forecast the skewness

in aggregate-market returns. In Section 6, we use an option-pricing metric to

evaluate the economic signiﬁcance of our results. Section 7 concludes.

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 349

2. Theoretical background

The model of Hong and Stein (1999), which provides the principal

motivation for our empirical tests, begins with the assumption that there are

two investors, A and B, each of whom receives a private signal about a stock’s

terminal payoﬀ. As a matter of objective reality, each investor’s signal contains

some useful information. However, each of the two investors only pays

attention to their own signal, even if that of the other investor is revealed to

them. This deviation from full Bayesian rationality – which can be thought of

as a form of overconﬁdence – leads to irreducible diﬀerences of opinion about

the stock’s value.

In addition to investors A and B, the model also incorporates a class of fully

rational, risk-neutral arbitrageurs. These arbitrageurs recognize that the best

estimate of the stock’s true value is formed by averaging the signals of A and B.

However, the arbitrageurs may not always get to see both of the signals,

because A and B face short-sales constraints. Importantly, the arbitrageurs

themselves are not short-sales constrained, so they can take inﬁnitely large

positive or negative positions. Perhaps the most natural interpretation of these

assumptions is not to take the short-sales constraint literally – as an absolute

technological impediment to trade – but rather to think of investors A and B as

institutions like equity mutual funds, many of whom are precluded by their

charters or operating policies from ever taking short positions.

3

In contrast, the

arbitrageurs might be thought of as hedge funds who are not subject to such

restrictions.

Even though investors A and B can be said to suﬀer from behavioral biases

(i.e., overconﬁdence), the market as a whole is eﬃcient, in the sense of there

being no predictability in returns. This is because of the presence of the risk-

neutral, unconstrained arbitrageurs. Hence, unlike most of the behavioral

ﬁnance literature, which relies on limited arbitrage, the model’s only

implications are for the higher-order moments of the return distribution.

There are two trading dates. To see how the model can generate

asymmetries, imagine that at time 1, investor B gets a pessimistic signal, so

that B’s valuation for the stock lies well below A’s. Because of the short-sales

constraint, B will simply sit out of the market, and the only trade will be

between investor A and the arbitrageurs. The arbitrageurs are rational enough

to ﬁgure out that B’s signal is below A’s, but they cannot know by how much.

3

In fact, Almazan et al. (1999) document that roughly 70% of mutual funds explicitly state (in

Form N-SAR that they ﬁle with the SEC) that they are not permitted to sell short. This is obviously

a lower bound on the fraction of funds that never take short positions. Moreover, Koski and

Pontiﬀ (1999) ﬁnd that 79% of equity mutual funds make no use whatsoever of derivatives (either

futures or options), suggesting that funds are also not ﬁnding synthetic ways to take short

positions.

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 350

Thus the market price at time 1 impounds A’s prior information, but does not

fully reﬂect B’s time-1 signal.

Next, move to time 2, and suppose that A gets a new positive signal. In this

case, A continues to be the more optimistic of the two, so A’s new time-2 signal

is incorporated into the price, while B’s time-1 signal remains hidden. On the

other hand, if A gets a bad signal at time 2, some of B’s previously hidden

information might come out. This is because as A bails out of the market at

time 2, the arbitrageurs learn something by observing if and at what price B

steps in and starts being willing to buy. In other words, there is information in

how B responds to A’s reduced demand for the stock – in whether or not B gets

up oﬀ the sidelines and provides buying support. Thus more information

comes out, and variance is greater, when the stock price is falling at time 2, as

opposed to rising. This greater variance on the downside implies that time-2

returns will be negatively skewed.

However, this logic is not suﬃcient to establish that unconditional returns

(i.e., the average across time 1 and time 2) are negatively skewed. There is a

countervailing positive-skewness eﬀect at time 1, since the most negative draws

of B’s signal are the ones that get hidden from the market at this time. When

A’s and B’s priors are suﬃciently close to one another, the positive time-1

skewness can actually overwhelm the negative time-2 skewness, so that returns

are on average positively skewed. Nevertheless, Hong and Stein show that if

the ex ante divergence of opinion (i.e., the diﬀerence in priors) between A and B

is great enough, the time-2 eﬀect dominates, and unconditional returns are

negatively skewed. It is this unconditional skewness feature – driven by the

short-sales constraint – that most clearly distinguishes the model of Hong and

Stein from other related models in which pent-up information is revealed

through the trading process (e.g., Grossman, 1988; Genotte and Leland, 1990;

Jacklin et al., 1992; and Romer, 1993). In these other models, returns are on

average symmetrically distributed, albeit potentially quite volatile.

Moreover, the ex ante divergence in priors between A and B – which Hong

and Stein denote by H – not only governs the extent of negative skewness, it

also governs trading volume. In particular, when H is large, trading volume is

unusually high at times 1 and 2. This high trading volume is associated with a

greater likelihood of B moving to the sidelines at time 1, and subsequently

moving oﬀ the sidelines at time 2 – precisely the mechanism that generates

negative skewness. Thus the comparative statics properties of the model with

respect to the parameter H lead to the prediction that increases in trading

volume should forecast more negative skewness. This comparative static result

holds regardless of whether unconditional skewness (averaged across diﬀerent

values of H) is positive or negative, and it forms the basis for our empirical

tests.

In order to isolate this particular theoretical eﬀect, we need to be aware of

other potentially confounding factors. For example, it is well known that

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 351

trading volume is correlated with past returns (Shefrin and Statman, 1985;

Lakonishok and Smidt, 1986; Odean, 1998b). And, as noted above, past

returns might also help predict skewness, if there are stochastic bubbles of the

sort described by Blanchard and Watson (1982).

4

Indeed, just such a pattern

has been documented in recent work by Harvey and Siddique (2000). To

control for this tendency, all of our regressions include a number of lags of past

returns on the right-hand side.

In a similar vein, one might also worry about skewness being correlated with

volatility. There are a number of models that can deliver such a correlation; in

the volatility-feedback model of Campbell and Hentschel (1992), for example,

higher levels of volatility are associated with more negative skewness. To the

extent that such an eﬀect is present in our data, we would like to know whether

turnover is forecasting skewness directly – as it should, according to the Hong-

Stein model – or whether it is really just forecasting volatility, which is in turn

correlated with skewness. To address this concern, all of our regressions

include some control for volatility, and we experiment with several ways of

doing this control.

3. Data

To construct our variables, we begin with data on daily stock prices and

monthly trading volume for all NYSE and AMEX ﬁrms, from the CRSP daily

and monthly stock ﬁles. Our sample period begins in July 1962, which is as far

back as we can get the trading volume data; because our regressions use many

lags, we do not actually begin to forecast returns until December 1965. We do

not include NASDAQ ﬁrms because we want to have a uniform and accurate

measure of trading volume, and the dealer nature of the NASDAQ market is

likely to render turnover in its stocks not directly comparable to that of NYSE

and AMEX stocks. We also follow convention and exclude ADRs, REITs,

closed-end funds, primes, and scoresFi.e., stocks that do not have a CRSP

share type code of 10 or 11.

For most of our analysis, we further truncate the sample by eliminating the

very smallest stocks in the NYSE/AMEX universe – in particular, those with a

market capitalization below the 20th percentile NYSE breakpoint. We do so

because our goal is to use trading volume as a proxy for diﬀerences of opinion.

Theoretical models that relate trading volume to diﬀerences of opinion

typically assume that transactions costs are zero. In reality, variations in

transactions costs are likely to be an important driver of trading volume, and

4

In the model of Coval and Hirshleifer (1998), there is also conditional negative skewness after

periods of positive returns, even though unconditional average skewness is zero.

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 352

more so for very small stocks. By eliminating the smallest stocks, we hope to

raise the ratio of signal (diﬀerences of opinion) to noise (transactions costs) in

our key explanatory variable. We also report some sensitivities in which the

smallest stocks are analyzed separately (see Table 4 below), and as one would

expect from this discussion, the coeﬃcients on turnover for this subsample are

noticeably smaller.

Our baseline measure of skewness, which we denote NCSKEW, for

‘‘negative coeﬃcient of skewness,’’ is calculated by taking the negative of

(the sample analog to) the third moment of daily returns, and dividing it by

(the sample analog to) the standard deviation of daily returns raised to the

third power. Thus, for any stock i over any six-month period t; we have

NCSKEW

it

¼ À nðn À1Þ

3=2

¸

R

3

it

ðn À1Þðn À2Þ

¸

R

2

it

3=2

; ð1Þ

where R

it

represents the sequence of de-meaned daily returns to stock i during

period t; and n is the number of observations on daily returns during the

period. In calculating NCSKEW, as well as any other moments that rely on

daily return data, we drop any ﬁrm that has more than ﬁve missing

observations on daily returns in a given period. These daily ‘‘returns’’ are,

more precisely, actually log changes in price. We use log changes as opposed to

simple daily percentage returns because they allow for a natural benchmark – if

stock returns were lognormally distributed, then an NCSKEW measure based

on log changes should have a mean of zero. We have also redone everything

with an NCSKEW measure based instead on simple daily percentage returns,

and none of our main results are aﬀected. Using simple percentage returns

instead of log changes does have two (predictable) eﬀects: (1) it makes

returns look more positively skewed on average and (2) it induces a

pronounced correlation between skewness and contemporaneously measured

volatility. However, given that we control for volatility in all of our regression

speciﬁcations, using simple percentage returns does not materially alter the

coeﬃcients on turnover and past returns.

Scaling the raw third moment by the standard deviation cubed allows for

comparisons across stocks with diﬀerent variances; this is the usual normal-

ization for skewness statistics (Greene, 1993). By putting a minus sign in front

of the third moment, we are adopting the convention that an increase in

NCSKEW corresponds to a stock being more ‘‘crash prone’’ – i.e., having a

more left-skewed distribution.

For most of our regressions, the daily ﬁrm-level returns that go into the

calculation of the NCSKEW variable are market-adjusted returns – the log

change in stock i less the log change in the value-weighted CRSP index for that

day. However, we also run everything with variations of NCSKEW based on

both (1) excess returns (the log change in stock i less the T-bill return) as well as

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 353

(2) beta-adjusted returns. As will be seen, these variations do not make much

diﬀerence to our results with NCSKEW.

In addition to NCSKEW, we also work with a second measure of return

asymmetries that does not involve third moments, and hence is less likely to be

overly inﬂuenced by a handful of extreme days. This alternative measure,

which we denote by DUVOL, for ‘‘down-to-up volatility,’’ is computed as

follows. For any stock i over any six-month period t; we separate all the days

with returns below the period mean (‘‘down’’ days) from those with returns

above the period mean (‘‘up’’ days), and compute the standard deviation for

each of these subsamples separately. We then take the log of the ratio of (the

sample analog to) the standard deviation on the down days to (the sample

analog to) the standard deviation on the up days. Thus we have

DUVOL

it

¼ log ðn

u

À1Þ

¸

DOWN

R

2

it

ðn

d

À1Þ

¸

UP

R

2

it

¸

; ð2Þ

where n

u

and n

d

are the number of up and down days, respectively. Again, the

convention is that a higher value of this measure corresponds to a more left-

skewed distribution. To preview, our results with NCSKEW and DUVOL are

for the most part quite similar, so it does not appear that they depend on a

particular parametric representation of return asymmetries.

In our regressions with ﬁrm-level data, we use nonoverlapping six-month

observations on skewness. In particular, the NCSKEW and DUVOL measures

are calculated using data from either January 1–June 30 or July 1–December 31

of each calendar year. We could alternatively use overlapping data, so that we

would have a new skewness measure every month, but there is little payoﬀ to

doing so, since, as will become clear shortly, we already have more than enough

statistical power as it is. We have, however, checked our results by re-running

everything using diﬀerent nonoverlapping intervals – e.g., February 1–July 31

and August 1–January 31, March 1–August 31 and September 1–February 28,

etc. In all cases, the results are essentially identical. When we turn to the time-

series regressions with aggregate-market data, statistical power becomes a real

issue, and we use overlapping observations.

The choice of a six-month horizon for measuring skewness is admittedly

somewhat arbitrary. In principle, the eﬀects that we are interested in could be

playing themselves out over a shorter horizon, so that trading volume on

Monday forecasts skewness for the rest of the week, but has little predictive

power beyond that. Unfortunately, the model of Hong and Stein does not give

us much guidance in this regard. Lacking this theoretical guidance, our choice

to use six months’ worth of daily returns to estimate skewness is driven more

by measurement concerns. For example, if we estimated skewness using only

one month’s worth of data, we would presumably have more measurement

error; this is particularly relevant given that a higher-order moment like

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 354

skewness is strongly inﬂuenced by outliers in the data. The important point to

note, however, is that to the extent that our measurement horizon does not

correspond well to the underlying theory, this should simply blur our ability to

ﬁnd what the theory predicts – i.e., it should make our tests too conservative.

Besides the skewness measures, the other variables that we use are very

familiar and do not merit much discussion. SIGMA

it

is the standard deviation

of stock i ’s daily returns, measured over the six-month period t: RET

it

is the

cumulative return on stock i; also measured over the six-month period t: When

we compute NCSKEW or DUVOL using either market-adjusted or beta-

adjusted returns, SIGMA and RET are computed using market-adjusted

returns. When we compute NCSKEW or DUVOL using excess returns,

SIGMA and RET are based on excess returns as well.

LOGSIZE

it

is the log of ﬁrm i ’s stock market capitalization at the end of

period t: BK/MKT

it

is ﬁrm i ’s book-to-market ratio at the end of period t:

LOGCOVER

it

is the log of one plus the number of analysts (from the I/B/E/S

database) covering ﬁrm i at the end of period t: TURNOVER

it

is the average

monthly share turnover in stock i; deﬁned as shares traded divided by shares

outstanding over period t:

In our baseline speciﬁcation, we work with detrended turnover, which we

denote DTURNOVER. The detrending is done very simply, by subtracting

from the TURNOVER variable a moving average of its value over the prior 18

months. Again, the rationale for doing this detrending is that, as a matter of

conservatism, we want to eliminate any component of turnover that can be

thought of as a relatively ﬁxed ﬁrm characteristic. This detrending is roughly

analogous to doing a ﬁxed-eﬀects speciﬁcation in a shorter-lived panel. Since

we have such a long time series, it makes little sense to require that ﬁrm eﬀects

be literally constant over the entire sample period. Instead, the detrending

controls for ﬁrm characteristics that adjust gradually.

Table 1 presents a variety of summary statistics for our sample. Panel A

shows the means and standard deviations of all of our variables for (1) the full

sample of individual ﬁrms, (2) ﬁve size-based subsamples, and (3) the market as

a whole, deﬁned as the value-weighted NYSE/AMEX index. (When working

with the market as a whole, all the variables are based on simple excess returns

relative to T-bills.) Panels B and C look at contemporaneous correlations and

autocorrelations, respectively, for the sample of individual ﬁrms. In Panels B

and C, as in most of our subsequent regression analysis, we restrict the sample

to those ﬁrms with a market capitalization above the 20th percentile NYSE

breakpoint.

One interesting point that emerges from Panel A is that while there is

negative skewness – i.e., positive mean values of NCSKEW and DUVOL – for

the market as a whole, the opposite is true for individual stocks, which are

positively skewed. This discrepancy can in principle be understood within the

strict conﬁnes of the Hong-Stein model, since, as noted above, the model

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 355

Table 1

Summary statistics

The sample period is from July 1962 to December 1998, except for LOGCOVER

t

, which is measured starting in December 1976. NCSKEW

t

is the

negative coeﬃcient of (daily) skewness, measured using market-adjusted returns in the six-month period t. DUVOL

t

is the log of the ratio of down-day

to up-day standard deviation, measured using market-adjusted returns in the six-month period t. SIGMA

t

is the standard deviation of (daily) market-

adjusted returns measured in the six-month period t. LOGSIZE

t

is the log of market capitalization measured at the end of period t. BK=MKT

t

is the

most recently available observation of the book-to-market ratio at the end of period t. LOGCOVER

t

is the log of one plus the number of analysts

covering the stock at the end of period t. DTURNOVER

t

is average monthly turnover in the six-month period t, detrended by a moving average of

turnover in the prior 18 months. TURNOVER

t

is the average monthly turnover measured in the six-month period t. RET

t

is the market-adjusted

cumulative return in the six-month period t. Size quintiles are determined using NYSE breakpoints.

All ﬁrms

Quintile 5

(largest)

ﬁrms

Quintile 4

ﬁrms

Quintile 3

ﬁrms

Quintile 2

ﬁrms

Quintile 1

(smallest)

ﬁrms

Market

portfolio

Panel A: First and second moments

NCSKEW

t

Mean À0.262 À0.139 À0.155 À0.198 À0.266 À0.362 0.268

Standard dev. 0.939 0.806 0.904 0.923 0.994 0.964 0.735

DUVOL

t

Mean À0.190 À0.128 À0.141 À0.171 À0.213 À0.224 0.172

Standard dev. 0.436 0.364 0.391 0.406 0.437 0.476 0.377

J

.

C

h

e

n

e

t

a

l

.

/

J

o

u

r

n

a

l

o

f

F

i

n

a

n

c

i

a

l

E

c

o

n

o

m

i

c

s

6

1

(

2

0

0

1

)

3

4

5

–

3

8

1

3

5

6

SIGMA

t

Mean 0.025 0.015 0.017 0.020 0.023 0.034 0.008

Standard dev. 0.018 0.005 0.007 0.008 0.010 0.023 0.003

LOGSIZE

t

Mean 5.177 8.249 6.860 5.924 4.984 3.121 N/A

Standard dev. 2.073 1.035 0.653 0.642 0.656 1.108

BK/MKT

t

Mean 0.983 0.667 0.782 0.824 0.935 1.275 N/A

Standard dev. 14.036 0.472 0.710 0.870 1.197 22.920

LOGCOVER

t

Mean 1.991 3.006 2.512 2.030 1.565 1.140 N/A

Standard dev. 0.840 0.431 0.503 0.563 0.564 0.508

DTURNOVER

t

Mean 0.001 0.000 0.002 0.002 0.001 À0.000 0.002

Standard dev. 0.066 0.039 0.040 0.042 0.046 0.095 0.005

TURNOVER

t

Mean 0.050 0.051 0.056 0.055 0.054 0.043 0.037

Standard dev. 0.075 0.050 0.055 0.060 0.063 0.098 0.022

RET

t

Mean 0.003 0.024 0.015 0.021 0.017 À0.019 0.029

Standard dev. 0.297 0.164 0.202 0.240 0.288 0.372 0.108

No. of obs. 100,898 13,988 14,291 14,727 16,651 41,241 421

J

.

C

h

e

n

e

t

a

l

.

/

J

o

u

r

n

a

l

o

f

F

i

n

a

n

c

i

a

l

E

c

o

n

o

m

i

c

s

6

1

(

2

0

0

1

)

3

4

5

–

3

8

1

3

5

7

NCSKEW

tÀ1

DUVOL

tÀ1

SIGMA

tÀ1

LOGSIZE

tÀ1

BK=MKT

tÀ1

LOGCOVER

tÀ1

DTURNOVER

tÀ1

TURNOVER

tÀ1

RET

tÀ1

Panel C: Autocorrelations and cross-correlations (using only ﬁrms above 20th percentile in size)

NCSKEW

t

0.047 0.059 À0.047 0.063 À0.030 0.056 0.022 0.032 0.043

DUVOL

t

0.061 0.090 À0.109 0.068 À0.011 0.066 0.016 À0.024 0.047

SIGMA

t

À0.008 À0.071 0.715 À0.292 À0.050 À0.218 0.042 0.318 À0.014

LOGSIZE

t

0.049 0.055 À0.342 0.976 À0.182 0.719 0.000 0.093 À0.011

BK/MKT

t

0.022 0.047 À0.067 À0.181 0.782 À0.027 0.022 0.017 À0.080

LOGCOVER

t

0.079 0.098 À0.257 0.736 À0.035 0.852 0.006 0.166 À0.079

DTURNOVER

t

À0.028 À0.028 À0.059 0.009 0.039 0.019 0.381 À0.130 0.119

TURNOVER

t

0.015 À0.052 0.294 0.104 0.029 0.179 0.195 0.781 0.086

RET

t

À0.002 0.006 À0.032 À0.042 0.051 À0.023 À0.013 À0.064 0.030

Table 1 (continued)

NCSKEW

t

DUVOL

t

SIGMA

t

LOGSIZE

t

BK/MKT

t

LOGCOVER

t

DTURNOVER

t

TURNOVER

t

RET

t

Panel B: Contemporaneous correlations (using only ﬁrms above 20th percentile in size)

NCSKEW

t

0.875 0.008 0.038 0.311 0.081 0.007 0.028 À0.302

DUVOL

t

À0.076 0.045 0.068 0.100 À0.013 À0.042 À0.371

SIGMA

t

À0.307 À0.056 À0.238 0.130 0.398 0.034

LOGSIZE

t

À0.213 0.729 0.002 0.101 À0.014

BK/MKT

t

À0.026 0.026 0.006 À0.104

LOGCOVER

t

À0.013 0.158 À0.080

DTURNOVER

t

0.376 0.133

TURNOVER

t

0.061

RET

t

J

.

C

h

e

n

e

t

a

l

.

/

J

o

u

r

n

a

l

o

f

F

i

n

a

n

c

i

a

l

E

c

o

n

o

m

i

c

s

6

1

(

2

0

0

1

)

3

4

5

–

3

8

1

3

5

8

allows for either positive or negative unconditional skewness, depending on

the degree of ex ante investor heterogeneity. In other words, if one is willing

to assume that diﬀerences of opinion about the market are on average

more pronounced than diﬀerences of opinion about individual stocks, the

model can produce negative skewness for the latter and positive skewness for

the former.

However, it is not clear that such an assumption is empirically defensible. An

alternative interpretation of the data in Table 1A is that even if the Hong-Stein

model provides a reasonable account of skewness in market returns, it must be

missing something when it comes to explaining the mean skewness of

individual stocks. For example, it might be that large positive events like

hostile takeovers (which the theory ignores) impart an added degree of positive

skewness to individual stocks but wash out across the market as a whole. This

view does not imply that we cannot learn something about the theory by

looking at ﬁrm-level data; the theory will certainly gain some credence if it does

a good job of explaining cross-sectional variation in skewness, even if it cannot

ﬁt the mean skewness at the ﬁrm level. Nevertheless, it is worth emphasizing

the caveat that, without further embellishments, the theory might not provide a

convincing rationale for everything that is going on at the individual stock

level.

The most noteworthy fact in Panel B of Table 1 is the contemporaneous

correlation between our two skewness measures, NCSKEW and DUVOL,

which is 0.88. While these two measures are quite diﬀerent in their

construction, they appear to be picking up much the same information. Also

worth pointing out is that the correlation between NCSKEW and SIGMA is

less than 0.01, and that between DUVOL and SIGMA is about À0.08; these

low correlations lend some preliminary (and comforting) support to the notion

that forecasting either of our skewness measures is a quite distinct exercise

from forecasting volatility. Panel C documents that, unlike SIGMA – which

has an autocorrelation coeﬃcient of 0.72 – neither of our skewness measures

has much persistence. For NCSKEW the autocorrelation is on the order of

0.05; for DUVOL it is 0.09.

4. Forecasting skewness in the cross-section

4.1. Baseline speciﬁcation

Table 2 presents our baseline cross-sectional regression speciﬁcation. We

pool all the data (excluding ﬁrms with market capitalization below the 20th

percentile NYSE breakpoint) and regress NCSKEW

it+1

against its own lagged

value, NCSKEW

it

, as well as SIGMA

it

, LOGSIZE

it

, DTURNOVER

it

, and

six lags of past returns, RET

it

yRET

itÀ5

. We also include dummy variables

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 359

for each time period t: The regression can be interpreted as an eﬀort to

predict – based on information available at the end of period t – cross-sectional

variation in skewness over period t þ1:

Table 2

Forecasting skewness in the cross-section: pooled regressions

The sample period is from July 1962 to December 1998 and includes only those ﬁrms with market

capitalization above the 20th percentile breakpoint of NYSE. The dependent variable is

NCSKEW

tþ1

; the negative coeﬃcient of (daily) skewness in the six-month period t þ1:

NCSKEW

tþ1

is computed based on market-adjusted returns, beta-adjusted returns and simple

excess returns in cols. 1–3, respectively. SIGMA

t

is the (daily) standard deviation of returns in the

six-month period t: LOGSIZE

t

is the log of market capitalization at the end of period t:

DTURNOVER

t

is average monthly turnover in the six-month period t; detrended by a moving

average of turnover in the prior 18 months. RET

t

yRET

tÀ5

are returns in the six-month periods t

through t À5 (these past returns are market adjusted in cols. 1À2 and excess in col. 3). All

regressions also contain dummies for each time period (not shown); t-statistics, which are in

parentheses, are adjusted for heteroskedasticity and serial correlation.

(1) Base case:

market-adjusted

returns

(2) Beta-adjusted

returns

(3) Excess

returns

NCSKEW

t

0.053 0.051 0.052

(7.778) (7.441) (7.920)

SIGMA

t

À4.566 À3.370 À2.701

(À7.180) (À5.242) (À4.706)

LOGSIZE

t

0.037 0.046 0.059

(11.129) (13.465) (19.110)

DTURNOVER

t

0.437 0.364 0.364

(3.839) (3.175) (3.329)

RET

t

0.218 0.197 0.221

(10.701) (9.638) (11.607)

RET

tÀ1

0.082 0.082 0.109

(4.296) (4.220) (6.175)

RET

tÀ2

0.103 0.108 0.089

(5.497) (5.675) (5.149)

RET

tÀ3

0.054 0.067 0.053

(2.830) (3.462) (3.001)

RET

tÀ4

0.062 0.058 0.041

(3.403) (3.133) (2.477)

RET

tÀ5

0.071 0.083 0.092

(3.759) (4.335) (5.257)

No. of obs. 51,426 51,426 51,426

R

2

0.030 0.031 0.082

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 360

In column 1, we use market-adjusted returns as the basis for computing the

NCSKEW measure. In column 2 we use beta-adjusted returns, and in column 3

we use simple excess returns. The results are quite similar in all three cases. In

particular, the coeﬃcients on detrended turnover are positive and strongly

statistically signiﬁcant in each of the three columns, albeit somewhat larger (by

about 20%) in magnitude when market-adjusted returns are used. (We expect

lower coeﬃcient estimates when using simple excess returns as compared to

market-adjusted returns – after all, DTURNOVER is a ﬁrm-speciﬁc variable,

so it should have more ability to explain skewness in the purely idiosyncratic

component of stock returns.) The past return terms are also always positive

and strongly signiﬁcant. Thus stocks that have experienced either a surge in

turnover or high past returns are predicted to have more negative skewness –

i.e., to become more crash-prone, all else equal. The coeﬃcient on size is also

positive, suggesting that negative skewness is more likely in large-cap stocks.

As noted above, the ﬁndings for past returns and size run broadly parallel to

previous work by Harvey and Siddique (2000). Nevertheless, there are several

distinctions between our results and theirs. To begin, ours are couched in a

multivariate regression framework, while theirs are based on univariate sorts.

But more signiﬁcantly, our measure of skewness is quite diﬀerent from theirs,

for two reasons. First, we look at daily returns, while they look at monthly

returns. Second, we look at individual stocks, while they look at portfolios of

stocks. The skewness of a portfolio of stocks is not the same thing as the

average skewness of its component stocks, especially if, as Harvey and

Siddique (2000) stress, coskewness varies systematically with ﬁrm character-

istics.

We have done some detailed comparisons to make these latter points

explicit. For 25 portfolios sorted on size and book-to-market, we have

computed both (1) the skewness of monthly portfolio returns, as in Harvey and

Siddique (2000), and (2) the average skewness of daily individual stock returns,

a measure analogous to what we use here. We can then ask the following:

Across the 25 portfolios, what is the correlation of the two skewness measures?

The answer is about 0.22, a relatively low, albeit signiﬁcantly positive,

correlation. Thus, while it might have been reasonable to conjecture – based on

the prior evidence in Harvey and Siddique (2000) – that our ﬁrm-level

NCSKEW variable would also be related to past returns and size, such results

were by no means a foregone conclusion.

As we have already stressed, the positive coeﬃcient on size is not something

one would have necessarily predicted ex ante based on the Hong-Stein model.

Nevertheless, it is possible to come up with rationalizations after the fact.

Suppose that managers can to some extent control the rate at which

information about their ﬁrms gets out. It seems plausible that if they uncover

good news, they will disclose all this good news right away. In contrast, if they

are sitting on bad news, they may try to delay its release, with the result that the

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 361

bad news dribbles out slowly. This behavior will tend to impart positive

skewness to ﬁrm-level returns, and may explain why returns on individual

stocks are on average positively skewed at the same time that market returns

are negatively skewed. Moreover, if one adds the further assumption that it is

easier for managers of small ﬁrms to temporarily hide bad news – since they

face less scrutiny from outside analysts than do managers of large ﬁrms – the

resulting positive skewness will be more pronounced for small ﬁrms. We return

to this idea in Section 4.5 below, and use it to develop some additional testable

implications.

4.2. Robustness

In Table 3 we conduct a number of further robustness checks. Everything

is a variation on column 1 of Table 2, and uses an NCSKEW measure

based on market-adjusted returns. First, in column 1 of Table 3, we truncate

outliers of the NCSKEW variable, setting all observations that are more

than three standard deviations from the mean in any period t to the three-

standard-deviation tail values in that period. This has little impact on

the results, suggesting that they are not driven by a handful of outlier

observations.

In column 2, we replace the DTURNOVER variable with its un-detrended

analog, TURNOVER. This means that we are now admitting into considera-

tion diﬀerences in turnover across ﬁrms that are not merely temporary

deviations from trend but more in the nature of long-run ﬁrm characteristics.

In other words, we are essentially removing our ﬁxed-eﬀect control from the

turnover variable. According to the theory, one might expect that long-run

cross-ﬁrm variation in turnover would also predict skewness – some ﬁrms

might be subject to persistently large diﬀerences in investor opinion, and these

too should matter for return asymmetries. The coeﬃcient estimate on

TURNVOVER in column 2 conﬁrms this notion, roughly doubling in

magnitude from its base-case value. This implies that our ﬁxed-eﬀect approach

of using DTURNOVER instead of TURNOVER everywhere else in the paper

is quite conservative – in doing so, we are throwing out a dimension of the data

that is strongly supportive of the theory.

In columns 3 and 4, we investigate whether our results are somehow tied to

the way that we have controlled for volatility. Recall that the central issue here

is whether DTURNOVER

it

is really forecasting NCSKEW

it+1

directly, or

whether it is instead forecasting SIGMA

it+1

, and showing up in the regression

only because SIGMA

it+1

is correlated with NCSKEW

it+1

. Ideally, we would

like to add a period-t control variable to the regression that is a good forecast

of SIGMA

it+1

, so that we can verify that DTURNOVER

it

is still signiﬁcant

even after the inclusion of this control. Our use of SIGMA

it

in the base-case

speciﬁcation can be motivated on the grounds that it is probably the best

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 362

univariate predictor of SIGMA

it+1

, given the very pronounced serial

correlation in the SIGMA variable.

But using just one past lag is not necessarily the best way to forecast

SIGMA

it+1

. One can presumably do better by allowing for richer dynamics. In

this spirit, we add in column 3 two further lags of SIGMA (SIGMA

itÀ1

and

SIGMA

itÀ2

) to the base-case speciﬁcation. These two lags are insigniﬁcant, and

hence our coeﬃcients on DTURNOVER

it

as well as on the six RET terms are

virtually unchanged. Motivated by the work of Glosten et al. (1993), who ﬁnd

that the eﬀect of past volatility on future volatility depends on the sign of the

past return, we also experiment with allowing two coeﬃcients on SIGMA

it

, one

for positive past returns and one for negative past returns. This variation (not

shown in the table) makes no diﬀerence to the results.

In column 4 we take our logic one step further. We create a ﬁtted value of

SIGMA

it+1

, which we denote by SIGMAHAT

it+1,

based on the following

information set available in period t: SIGMA

it

, SIGMA

itÀ1

, SIGMA

itÀ2

,

LOGSIZE

it

, DTURNOVER

it

, and RET

it

yRET

itÀ5

. We then replace

SIGMA

it

in the base case with this ﬁtted value of future volatility,

SIGMAHAT

it+1

. This is equivalent to an instrumental-variables regression

in which future volatility SIGMA

it+1

is included on the right-hand side, but is

instrumented using the information available in period t: As can be seen, this

variation leads to almost exactly the same results as in the base case.

Overall, based on the evidence in columns 3 and 4 of Table 3, we conclude

that it is highly unlikely that our base-case success in forecasting NCSKEW

with the DTURNOVER and RET variables arises because these variables are

able to forecast SIGMA. In other words, these variables really appear to be

predicting cross-ﬁrm diﬀerences in the asymmetry of stock returns, rather than

just diﬀerences in volatility.

In column 5, we add the book-to-market ratio, BK/MKT, to the

base-case speciﬁcation. This variable attracts a signiﬁcant negative coeﬃcient,

which means that it tells the same story as the past-return terms: glamour

stocks, like those with high past returns, are more crash-prone. However, the

addition of BK/MKT has no impact on the DTURNOVER coeﬃcient.

In column 6, we use the DUVOL measure of return asymmetry as the left-

hand-side variable in place of NCSKEW. Although the diﬀerence in units

precludes a direct comparison of the point estimates, the qualitative patterns

are generally the same as in the corresponding speciﬁcation in column 1 of

Table 2. Indeed, the t-statistic on DTURNOVER is actually a bit higher (4.35

vs. 3.84) as is the R

2

of the regression (6.7% vs. 3.0%).

Finally, in an unreported sensitivity, we check to make sure our results are

robust to how we have modeled the eﬀect of the lagged skewness variable,

NCSKEW

it

. Instead of estimating just one coeﬃcient on NCSKEW

it

, we allow

this eﬀect to be a function of the realization of NCSKEW

it

itself. We

implement this by interacting NCSKEW

it

with ﬁve dummy variables,

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 363

Table 3

Forecasting skewness in the cross-section: robustness checks

The sample period is from July 1962 to December 1998 and includes only those ﬁrms with market capitalization above the 20th percentile breakpoint

of NYSE. In columns 1–5, the dependent variable is NCSKEW

tþ1

; the negative coeﬃcient of (daily) skewness in the six-month period t þ1: In column

6, the dependent variable is DUVOL

tþ1

; the log of the ratio of down-day to up-day standard deviation in the six-month period t þ1: In all columns,

returns are market-adjusted. SIGMA

t

is the standard deviation of (daily) returns in the six-month period t: LOGSIZE

t

is the log of market

capitalization at the end of period t: BK/MKT

t

is the most recently available observation of the book-to-market ratio at the end of period t:

DTURNOVER

t

is average monthly turnover in the six-month period t; detrended by a moving average of turnover in the prior 18 months, except in

column 3, where turnover is not detrended. RET

t

yRET

tÀ5

are returns in the six-month periods t through t À5: SIGMAHAT

tþ1

is the predicted value

of SIGMA

tþ1

calculated from a regression of SIGMA

tþ1

on SIGMA

t

,y, SIGMA

tÀ2

; LOGSIZE

t

, DTURNOVER

t

, and RET

t

...RET

tÀ5

: All

regressions also contain dummies for each time period (not shown); t-statistics, which are in parentheses, are adjusted for heteroskedasticity and serial

correlation.

(1) Outliers

truncated

(2) Turnover

not detrended

(3) More lags

of past volatility

(4) Fitted future

volatility

(5) Book-to-

market

(6) Using

DUVOL

t+1

NCSKEW

t

0.050 0.053 0.053 0.051 0.054 0.096

(DUVOL

t

in col. 6) (8.675) (7.837) (7.663) (7.454) (7.750) (16.627)

SIGMAHAT

tþ1

À6.178

(À7.180)

SIGMA

t

À4.994 À6.618 À3.953 À4.999 À4.956

(À8.938) (À9.822) (À3.751) (À7.552) (À15.698)

SIGMA

tÀ1

À0.460

(À0.384)

SIGMA

tÀ2

À0.367

(À0.353)

LOGSIZE

t

0.035 0.033 0.037 0.034 0.035 0.014

(12.047) (9.980) (10.898) (9.351) (10.095) (9.572)

BK/MKT

t

À0.020

(À3.808)

J

.

C

h

e

n

e

t

a

l

.

/

J

o

u

r

n

a

l

o

f

F

i

n

a

n

c

i

a

l

E

c

o

n

o

m

i

c

s

6

1

(

2

0

0

1

)

3

4

5

–

3

8

1

3

6

4

DTURNOVER

t

0.375 0.761 0.411 0.387 0.455 0.202

(TURNOVER

t

in col. 2) (3.729) (7.685) (3.459) (3.410) (3.848) (4.346)

RET

t

0.206 0.217 0.218 0.208 0.213 0.142

(11.787) (10.887) (10.761) (10.249) (10.071) (15.810)

RET

tÀ1

0.075 0.071 0.083 0.084 0.081 0.014

(4.587) (3.828) (4.329) (4.428) (4.087) (1.671)

RET

tÀ2

0.100 0.088 0.104 0.106 0.098 0.045

(6.273) (4.734) (5.472) (5.621) (5.038) (5.587)

RET

tÀ3

0.049 0.033 0.054 0.056 0.056 0.009

(3.030) (1.727) (2.819) (2.943) (2.816) (1.131)

RET

tÀ4

0.048 0.041 0.060 0.064 0.051 0.014

(3.084) (2.287) (3.337) (3.523) (2.722) (1.808)

RET

tÀ5

0.057 0.054 0.072 0.073 0.066 0.014

(3.580) (2.923) (3.789) (3.820) (3.324) (1.705)

No. of obs. 51,426 52,229 51,393 51,426 48,630 51,426

R

2

0.039 0.031 0.030 0.030 0.030 0.067

J

.

C

h

e

n

e

t

a

l

.

/

J

o

u

r

n

a

l

o

f

F

i

n

a

n

c

i

a

l

E

c

o

n

o

m

i

c

s

6

1

(

2

0

0

1

)

3

4

5

–

3

8

1

3

6

5

one corresponding to each quintile of NCSKEW

it

. In other words, we estimate

ﬁve separate slope coeﬃcients on lagged skewness, depending on the

quintile that lagged skewness falls in. As it turns out, while there appear to

be some modest nonlinearities in the eﬀect of lagged skewness, these

nonlinearities do not at all impact the coeﬃcients on any of the other variables

of interest.

4.3. Cuts on ﬁrm size

In Table 4, we disaggregate our base-case analysis by size. We take the

speciﬁcation from column 1 of Table 2 and run it separately for ﬁve size-based

subsamples, corresponding to quintiles based on NYSE breakpoints. (Recall

that in Tables 2 and 3, we omit the smallest of these ﬁve quintiles from

our sample.) Two conclusions stand out. First, as suspected, the coeﬃcient

on DTURNOVER for the smallest category of ﬁrms is noticeably lower

than for any other group, albeit still positive.

5

Again, this is probably

because variation in turnover for these tiny ﬁrms is driven in large part by

variation in trading costs, whereas our theory requires a good proxy for

diﬀerences of opinion. Second, once one moves beyond the smallest quintile,

the coeﬃcients look reasonably stable. There is certainly no hint that the eﬀects

that we are interested in go away for larger ﬁrms. Indeed, the highest point

estimate for the DTURNOVER coeﬃcient comes from the next-to-largest

quintile.

The fact that the coeﬃcients on DTURNOVER are robust for large ﬁrms is

not surprising in light of the underlying theory. As we have emphasized, the

model of Hong and Stein is not predicated on impediments to arbitrage – it

incorporates a class of fully risk-neutral arbitrageurs who can take inﬁnite long

or short positions. Thus, as long as some investors other than the arbitrageurs

(e.g., mutual funds) continue to be short-sales constrained, the model does not

have the feature that the key eﬀects diminish as one moves to larger stocks,

where arbitrage activity is presumably more eﬃcient. This is in contrast to

behavioral models based on limited arbitrage (e.g., DeLong et al., 1990) whose

implications for return predictability are often thought of as applying more

forcefully to small stocks.

6

5

Also for these smallest ﬁrms, the coeﬃcient on SIGMA changes signs, and the coeﬃcients on

the past-return terms are smaller and much less signiﬁcant. Given the potential distortions

associated with infrequent trading and price discreteness for this group, we are reluctant to hazard

an economic interpretation for these anomalies.

6

Several recent papers ﬁnd that predictability – based on either ‘‘momentum’’ or ‘‘value’’

strategies – is stronger in small-cap stocks (see, e.g., Fama, 1998; Hong et al., 2000; and Griﬃn and

Lemmon, 1999).

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 366

4.4. Stability over subperiods

In Table 5, we examine the intertemporal stability of our baseline regression,

using a Fama-MacBeth (1973) approach. Speciﬁcally, we run a separate, purely

cross-sectional variant of the regression in column 1 of Table 2 for every one of

Table 4

Forecasting skewness in the cross-section: cuts by ﬁrm size

The sample period is from July 1962 to December 1998. The dependent variable in all columns is

NCSKEW

tþ1

; the negative coeﬃcient of (daily) skewness in the six-month period t þ1: In all

columns, returns are market-adjusted. SIGMA

t

is the standard deviation of (daily) returns in the

six-month period t: LOGSIZE

t

is the log of market capitalization at the end of period t:

DTURNOVER

t

is average monthly turnover in the six-month period t; detrended by a moving

average of turnover in the prior 18 months. RET

t

yRET

tÀ5

are returns in the six-month periods t

through t À5: All regressions also contain dummies for each time period (not shown); t-statistics

are adjusted for heteroskedasticity and serial correlation. Firm size cuts are based on NYSE

breakpoints.

Quintile 5

(largest)

ﬁrms

Quintile 4

ﬁrms

Quintile 3

ﬁrms

Quintile 2

ﬁrms

Quintile 1

(smallest)

ﬁrms

NCSKEW

t

0.053 0.059 0.054 0.043 0.045

(3.758) (3.653) (4.341) (3.690) (5.431)

SIGMA

t

À3.043 À4.362 À4.409 À4.062 2.894

(À1.243) (À2.263) (À3.771) (À4.612) (8.793)

LOGSIZE

t

0.009 0.057 0.049 0.105 0.066

(1.021) (1.855) (1.590) (3.639) (8.800)

DTURNOVER

t

0.404 0.637 0.551 0.264 0.079

(1.812) (2.450) (2.554) (1.391) (1.072)

RET

t

0.260 0.335 0.215 0.155 0.010

(5.637) (7.000) (5.359) (4.682) (0.569)

RET

tÀ1

0.047 0.001 0.083 0.134 0.017

(1.009) (0.024) (2.157) (4.269) (1.076)

RET

tÀ2

0.163 0.165 0.104 0.069 0.014

(3.554) (3.726) (2.651) (2.298) (0.816)

RET

tÀ3

0.025 0.078 0.093 0.033 0.028

(0.535) (1.682) (2.334) (1.112) (1.823)

RET

tÀ4

0.162 0.101 0.071 0.006 0.014

(3.637) (2.540) (1.852) (0.215) (0.864)

RET

tÀ5

0.128 0.089 0.134 0.013 À0.010

(2.906) (1.801) (3.503) (0.465) (À0.632)

No. of obs. 12,749 12,520 12,407 13,750 29,165

R

2

0.035 0.030 0.024 0.029 0.028

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 367

Table 5

Forecasting skewness in the cross-section: Fama-MacBeth approach

The sample period is from July 1962 to December 1998 and includes only those ﬁrms with market

capitalization above the 20th percentile breakpoint of NYSE. The dependent variable is

NCSKEW

tþ1

; the negative coeﬃcient of (daily) skewness in the six-month period t þ1: In all

cases, returns are market-adjusted. The speciﬁcation is the same as in col. 1 of Table 2. SIGMA

t

is

the standard deviation of (daily) returns in the six-month period t: LOGSIZE

t

is the log of market

capitalization at the end of period t: DTURNOVER

t

is average monthly turnover in the six-month

period t; detrended by a moving average of turnover in the prior 18 months. RET

t

yRET

tÀ5

are

returns in the six-month periods t through t À5: Panel A reports only the coeﬃcient on

DTURNOVER

t

for each period. Panel B reports the mean coeﬃcients for diﬀerent subperiods, and

the associated t-statistics, based on the time-series standard deviations of the coeﬃcients, and

adjusted for serial correlation.

1960s 1970s 1980s 1990s

Panel A: Period-by-period regressions (12/1965 to 6/1998); coeﬃcient on detrended turnover only

12/1965 0.383 6/1970 0.129 6/1980 1.730 6/1990 1.780

6/1966 1.053 12/1970 0.973 12/1980 0.707 12/1990 À0.194

12/1966 0.248 6/1971 1.145 6/1981 À0.156 6/1991 1.065

6/1967 À0.081 12/1971 0.269 12/1981 À0.757 12/1991 0.058

12/1967 0.201 6/1972 0.955 6/1982 2.738 6/1992 0.835

6/1968 0.468 12/1972 À0.207 12/1982 0.373 12/1992 0.569

12/1968 1.218 6/1973 0.148 6/1983 2.314 6/1993 0.161

6/1969 1.101 12/1973 À0.904 12/1983 0.334 12/1993 0.803

12/1969 0.498 6/1974 2.257 6/1984 À0.751 6/1994 0.459

12/1974 0.579 12/1984 0.545 12/1994 0.372

6/1975 À0.363 6/1985 2.448 6/1995 1.026

12/1975 À0.083 12/1985 À0.182 12/1995 À0.913

6/1976 0.029 6/1986 À0.686 6/1996 À0.631

12/1976 À0.016 12/1986 0.388 12/1996 1.981

6/1977 0.876 6/1987 0.672 6/1997 0.643

12/1977 1.901 12/1987 0.464 12/1997 0.062

6/1978 0.918 6/1988 0.404 6/1998 0.381

12/1978 1.512 12/1988 À0.941

6/1979 1.506 6/1989 0.121

12/1979 0.210 12/1989 À0.038

All

periods

Late

1960s 1970s 1980s 1990s

Panel B: Average coeﬃcients by subperiods

NCSKEW

t

0.063 0.099 0.079 0.064 0.024

(4.880) (2.173) (4.517) (2.707) (1.258)

SIGMA

t

À5.017 À11.577 À9.507 À3.884 2.407

(À2.312) (À2.614) (À3.063) (À1.061) (0.288)

LOGSIZE

t

0.030 0.005 0.040 0.027 0.032

(4.141) (0.222) (2.216) (2.776) (4.200)

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 368

the 66 six-month periods in our sample. We then take simple time-averages of

the cross-sectional regression coeﬃcients over various subperiods, and

compute the associated t-statistics based on the time-series properties of the

coeﬃcients (and adjusting for serial correlation). In Panel A of Table 5, we

display the coeﬃcient on DTURNOVER from every one of the 66 regressions.

In Panel B, we show time-averages of all the regression coeﬃcients for the full

sample and for each of four decade-based subperiods: the 1960s, the 1970s, the

1980s, and the 1990s.

The overriding conclusion that emerges from Table 5 is that our results are

remarkably stable over time. For example, the coeﬃcient on DTURNOVER –

which averages 0.532 over the full sample period – reaches a low of 0.486 in the

1980s and a high of 0.592 in the 1970s. Moreover, even taken alone, three of

the four decade-based subperiods produce a statistically signiﬁcant result for

DTURNOVER.

4.5. Why are small stocks more positively skewed?

One of the most striking patterns that we have documented is that

small stocks are more positively skewed than large stocks. Given that

Table 5 (continued)

All

periods

Late

1960s 1970s 1980s 1990s

DTURNOVER

t

0.532 0.565 0.592 0.486 0.497

(3.981) (2.280) (2.549) (1.372) (2.326)

RET

t

0.249 0.335 0.234 0.229 0.242

(6.614) (1.807) (3.909) (3.663) (2.312)

RET

tÀ1

0.099 0.229 0.026 0.085 0.132

(3.287) (1.684) (0.427) (1.838) (2.711)

RET

tÀ2

0.139 0.100 0.222 0.132 0.071

(4.357) (1.098) (3.452) (2.323) (1.387)

RET

tÀ3

0.082 0.057 0.139 0.017 0.104

(2.555) (0.645) (2.596) (0.341) (1.513)

RET

tÀ4

0.081 0.045 0.091 0.044 0.133

(2.887) (0.390) (1.524) (0.917) (2.453)

RET

tÀ5

0.082 0.139 0.056 0.036 0.136

(1.967) (1.767) (1.014) (0.193) (1.492)

No. of obs. 66 9 20 20 17

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 369

this pattern is not clearly predicted by any existing theories (of which we

are aware) we have had to come up with a new hypothesis after the fact in

order to rationalize it. As described above, this hypothesis begins with the

assumption that managers have some discretion over the disclosure of

information, and prefer to announce good news immediately, while allowing

bad news to dribble out slowly. This behavior tends to impart a degree of

positive skewness to returns. Moreover, if there is more scope for such

managerial discretion in small ﬁrms – perhaps because they face less scrutiny

from security analysts – then the positive-skewness eﬀect will be more

pronounced in small stocks.

The one satisfying thing about this after-the-fact hypothesis is

that it yields new testable predictions. Speciﬁcally, positive skewness

ought to be greater in ﬁrms with fewer analysts, after controlling for

size. Table 6 investigates this prediction, taking our baseline speciﬁca-

tions for both NCSKEW and DUVOL, and in each case adding LOGCOVER,

the log of one plus the number of analysts covering the stock. (The

sample period in Table 6 is shorter, since analyst coverage is not

available from I/B/E/S prior to December 1976.) The coeﬃcients on

LOGCOVER have the predicted positive sign, and are strongly statistically

signiﬁcant.

7

The coeﬃcients on LOGSIZE go down a bit, but remain

signiﬁcant as well. Nothing else changes.

We do not mean to cast Table 6 as a deﬁnitive test of the discretio-

nary-disclosure hypothesis; this idea is outside the main scope of the paper,

and pursuing it more seriously would take us too far aﬁeld. Nevertheless,

it is comforting to know that the most obvious auxiliary prediction of the

hypothesis is borne out in the data, and that as a result, we at least have a

plausible explanation for what would otherwise be a puzzling feature of

our data.

5. Forecasting market skewness

We now turn to forecasting skewness in the returns to the aggregate market.

While this is in many ways the more interesting exercise from an economic

viewpoint, our statistical power is severely limited. Thus it may be asking too

much to expect that the results here will be strongly statistically signiﬁcant in

their own right; rather, one might more reasonably hope that they look

qualitatively similar to those from the cross-sectional regressions.

7

After developing the discretionary-disclosure hypothesis, and running the regressions in

Table 6, we became aware of a closely related working paper by Damodaran (1987). Using data

from 1979 to 1983, he also ﬁnds that ﬁrms with fewer analysts have more positively skewed returns.

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 370

Our deﬁnition of the aggregate market is the value-weighted NYSE-AMEX

index, and all returns are excess returns relative to T-bills. To avoid any

temptation to further mine the data, we use essentially the same speciﬁcation as

Table 6

Forecasting skewness in the cross-section: adding analyst coverage

The sample period is from December 1976 to December 1998 and includes only those ﬁrms with

market capitalization above the 20th percentile breakpoint of the NYSE. The dependent variable in

col. 1 is NCSKEW

tþ1

; the negative coeﬃcient of skewness in the six-month period t þ1; and in col.

2 it is DUVOL

tþ1

; the log of the ratio of down-day to up-day standard deviation in the six-month

period t þ1: SIGMA

t

is the standard deviation of (daily) returns in the six-month period t.

LOGSIZE

t

is the log of market capitalization at the end of period t. LOGCOVER

t

is the log of one

plus the number of analysts covering the stock at the end of period t. DTURNOVER

t

is average

monthly turnover in the six-month period t; detrended by a moving average of turnover in the prior

18 months. RET

t

yRET

tÀ5

are returns in the six-month periods t through t À5: All regressions

also contain dummies for each time period (not shown); t-statistics are adjusted for

heteroskedasticity and serial correlation.

(1) Using

NCSKEW

tþ1

measure

(2) Using

DUVOL

tþ1

measure

NCSKEW

t

0.049 0.090

(DUVOL

t

in col.2) (6.649) (13.945)

SIGMA

t

À3.188 À4.022

(À4.366) (À11.586)

LOGSIZE

t

0.032 0.011

(7.992) (6.665)

DTURNOVER

t

0.504 0.207

(3.504) (3.648)

LOGCOVER

t

0.019 0.006

(4.059) (3.288)

RET

t

0.219 0.135

(8.767) (12.599)

RET

tÀ1

0.085 0.010

(3.681) (1.044)

RET

tÀ2

0.100 0.040

(4.410) (4.253)

RET

tÀ3

0.058 0.006

(2.564) (0.683)

RET

tÀ4

0.065 0.012

(3.140) (1.290)

RET

tÀ5

0.055 0.006

(2.493) (0.705)

No. of obs. 40,688 40,688

R

2

0.025 0.051

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 371

in our baseline cross-sectional analysis.

8

Speciﬁcally, we use all the same right-

hand-side variables, except for LOGSIZE and the time dummies. The

DTURNOVER variable is constructed exactly as before, by detrending

TURNOVER with its own moving average over the prior 18 months.

In an eﬀort to get the most out of the little time-series data that we have, we

now use monthly overlapping observations. (The t-statistics we report are

adjusted accordingly.) This yields a total of 401 observations that can be used

in the regressions. However, a new concern that arises with the time-series

approach is the extent to which our inferences are dominated by the enormous

daily movements during October 1987. To address this concern, we also re-run

our regressions omitting October 1987. This brings us down to 371

observations.

9

The results are summarized in Table 7. In columns 1 and 2 we use the

NCSKEW measure of skewness, and run the regressions with and without

October 1987, respectively. In columns 3 and 4 we use the DUVOL measure of

skewness, and again run the regression with and without October 1987. The

basic story is the same in all four columns. The six past-return terms are always

positive, and many are individually statistically signiﬁcant. In contrast, the

coeﬃcient on DTURNOVER, while positive in each of the four regressions, is

never statistically signiﬁcant. Dropping October 1987 seems to increase the

precision of the DTURNOVER coeﬃcient estimate somewhat, but the highest

t-statistic across the four speciﬁcations is only 1.15.

Nevertheless, holding statistical signiﬁcance aside, the point estimates

suggest large quantitative eﬀects relative to the cross-sectional regres-

sions. Indeed, the coeﬃcients on DTURNOVER and the RET terms are

now on the order of ten times bigger than they were in the previous tables.

Thus both turnover and past returns could well be very important for

forecasting the skewness of market returns, but we lack the statistical power to

assert these conclusions – particularly regarding turnover – with much

conﬁdence.

In light of this power problem, we obtained an alternative series on NYSE

volume going back to 1928 from Gallant et al. (1992), who in turn take it from

the S&P Security Price Record. The one drawback with these data is that we

cannot use them to literally calculate turnover, since they give only the number

of shares traded and not the number of shares outstanding. Thus we cannot

8

Harvey and Siddique (1999) build an autoregressive conditional skewness model for aggregate-

market returns; while their speciﬁcation is very diﬀerent from that here, it shares the common

element that lagged skewness helps to forecast future skewness.

9

We lose 30 observations because we do not allow any observation on NCSKEW, DUVOL,

SIGMA, or DTURNOVER to enter the regression if it draws on data from October 1987. Because

of the detrending, the DTURNOVER variable in any given month draws on 24 months’ worth of

data.

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 372

quite reproduce our baseline speciﬁcations for the longer post-1928 sample

period. Nevertheless, using detrended values of raw trading volume to

approximate detrended turnover, we get results for this sample period that

are very similar to those reported in Table 7.

Table 7

Forecasting skewness in the market: time-series regressions

The sample period is from July 1962 to December 1998 and is based on market returns in excess of

the risk-free rate, where the market is deﬁned as the value-weighted portfolio of all NYSE/AMEX

stocks. The dependent variable in cols. 1 and 2 is NCSKEW

tþ1

; the negative coeﬃcient of skewness

in the six-month period t þ1; and in cols. 3 and 4 it is DUVOL

tþ1

; the log of the ratio of down-day

to up-day standard deviation in the six-month period t þ1: SIGMA

t

is the standard deviation of

(daily) market returns in the six-month period t: DTURNOVER

t

is the average monthly turnover

of the market portfolio in the six-month period t; detrended by a moving average of turnover in the

prior 18 months. RET

t

yRET

tÀ5

are returns in the six-month periods t through t À5; t-statistics,

which are in parentheses, are adjusted for heteroskedasticity and serial correlation.

(1) Dep. variable

is NCSKEW

tþ1

(2) Dep. variable

is NCSKEW

tþ1

;

excluding 10/87

(3) Dep. variable

is DUVOL

tþ1

(4) Dep. variable

is DUVOL

tþ1

;

excluding 10/87

NCSKEW

t

0.100 0.123 0.221 0.217

(DUVOL

t

in

col.3 and 4)

(0.855) (1.232) (1.842) (0.844)

SIGMA

t

18.183 13.708 1.196 À3.574

(1.137) (0.749) (0.156) (À0.300)

DTURNOVER

t

6.002 9.349 6.324 9.462

(0.262) (0.828) (0.704) (1.148)

RET

t

2.647 1.809 1.484 1.184

(4.147) (4.406) (4.168) (3.398)

RET

tÀ1

1.585 1.077 0.482 0.332

(3.086) (2.939) (1.481) (1.061)

RET

tÀ2

1.473 0.926 0.554 0.386

(2.242) (1.922) (1.898) (1.357)

RET

tÀ3

0.589 0.443 0.126 0.017

(0.602) (0.734) (0.325) (0.049)

RET

tÀ4

1.283 0.680 0.475 0.287

(2.264) (1.575) (1.726) (0.968)

RET

tÀ5

1.187 0.596 0.686 0.470

(2.288) (1.930) (2.326) (1.753)

No. of obs. 401 371 401 371

R

2

0.265 0.264 0.304 0.274

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 373

6. Economic signiﬁcance of the results: an option-pricing metric

Thus far, we have focused on the statistical signiﬁcance of our results, and

have not really asked whether they imply magnitudes that are economically

meaningful. Assessing economic signiﬁcance in the current context is a bit

tricky. The thought experiment that is typically undertaken is something like

this: suppose that the right-hand-side variable of interest – in this case,

DTURNOVER – is shocked by two standard deviations. How much does the

left-hand-side variable – NCSKEW or DUVOL – move? What makes things

diﬃcult here is that most people have little sense for what would constitute an

economically interesting change in NCSKEW or DUVOL.

To help frame things in a way that is hopefully more intuitive, we can

translate statements about NCSKEW into statements about the prices of out-

of-the-money put options. The idea behind our metric can be understood as

follows. Imagine that you are pricing an out-of-the-money put on a stock

whose returns you initially believe to be symmetrically distributed – i.e., a stock

for which you believe that NCSKEW is equal to zero. Now the stock

experiences a surge in turnover. As a result, you revise your forecast of

NCSKEW, using the DTURNOVER coeﬃcient estimate from our regressions.

Given this new forecast of NCSKEW – but holding volatility ﬁxed – by how

much does the value of the put option increase?

To answer this sort of question precisely, we need to (1) ﬁnd an option-

pricing model that admits skewness in returns and (2) create a mapping from

the parameters of this model to our NCSKEW variable. The model we use is

the stochastic-volatility model of Das and Sundaram (1999), in which the

dynamics of stock prices are summarized by the following two diﬀusion

equations:

dp

t

¼ a dt þV

1=2

t

dz

1

; ð3Þ

dV

t

¼ kðV

0

ÀV

t

Þdt þZV

1=2

t

dz

2

; ð4Þ

where p

t

is the log of the stock price, a is the expected return on the stock, V

t

is

the current variance, k is the mean reversion parameter for the variance

process, V

0

is the long-run mean level of variance, and Z is the volatility of the

variance process. The two Wiener processes dz

1

and dz

2

are instantaneously

correlated, with a correlation coeﬃcient of r: The parameter r is the one of

central interest for our purposes, as it governs the skewness of stock returns:

when r=0, log returns are symmetrically distributed; when ro0, log returns

are negatively skewed.

In order to map the parameters of the option-pricing model into our

NCSKEW variable, we draw on formulas given by Das and Sundaram that

express the skewness in daily log returns as a function of the diﬀusion

parameters. If we are willing to ﬁx all the other parameters besides r; these

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 374

formulas allow us to ask to what value of r a given value of NCSKEW

corresponds. Once we have obtained the implied value of r in this way, we can

calculate options prices and thereby see the impact of a given value of

NCSKEW.

Table 8 illustrates the results of this exercise. Consider ﬁrst Panel A,

where the parameters are chosen so as to be reasonable for individual

stocks: k=1, V

0

=0.16, V

t

=0.16, and Z ¼ 0:4: (Setting the variance V to

0.16 corresponds to an annual standard deviation of returns of 40%.) We also

set the stock price P=100, and the riskless rate r=0. We begin with a

hypothetical ﬁrm 1, which has symmetrically distributed returns – i.e., it has

NCSKEW=0. This is equivalent to a value of r=0. Next, we take ﬁrm 2,

which is identical to ﬁrm 1, except that it has a two-standard-deviation higher

value of DTURNOVER. The standard deviation of DTURNOVER (for ﬁrms

above the 20th percentile NYSE breakpoint) is 0.042, and from Table 2,

column 1, the coeﬃcient on DTURNOVER is 0.437. Hence the value of

NCSKEW for ﬁrm 2 is 0.037 (2 Â0.042 Â0.437=0.037). Using Eq. (21) in Das

and Sundaram (1999, p. 223) this value of skewness in daily returns for ﬁrm 2

can be shown to imply r=À0.38, assuming all the other diﬀusion parameters

stay ﬁxed.

Panel A of Table 8 displays the impact of this change in r for the prices of

six-month European put options. That is, it calculates put prices for both ﬁrm

1 (which has NCKSEW=0 and thus r=0) and ﬁrm 2 (which has

NCSKEW=0.037 and thus r=À0.38). As can be seen, the impact on put

prices is substantial, particularly if one goes relatively far out-of-the-money.

For example, a put with a strike of 70 is worth 1.20 for ﬁrm 1 but 1.44 for ﬁrm

2, an increase of 20.14%. Or expressed in a diﬀerent way, the ﬁrm 1 put has a

Black-Scholes (1973) implied volatility of 40.33%, while the ﬁrm 2 put has an

implied volatility of 42.50%.

Panel B undertakes a similar experiment to gauge the signiﬁcance of our

time-series results. We keep all the diﬀusion parameters the same as in Panel A,

except that we now set V

0

¼ V

t

¼ 0:04; corresponding to an annual standard

deviation of returns of 20%. For the market as a whole, the standard deviation

of DTURNOVER is 0.005 (see Table 1A). Using the coeﬃcient estimate on

DTURNOVER of 6.00 from Table 7, column 1, a two-standard-deviation

shock to DTURNOVER translates into a movement of 0.06 in the NCSKEW

variable. Given the other diﬀusion parameters, this value of 0.06 for NCSKEW

is equivalent to r=À0.33.

Panel B then compares the prices of six-month European puts across two

regimes, the ﬁrst with r=0 and the second with r=À0.33. Once again, the

diﬀerences appear to be meaningful. For example, a put with a strike price of

85 is worth 0.86 in regime 1 but 1.07 in regime 2, an increase of 24.66%. The

corresponding implied volatilities are 20.36% and 21.84%, respectively. These

results reinforce a point made above: while the time-series estimates are

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 375

Table 8

Economic signiﬁcance of trading volume for skewness in stock returns: an option-pricing metric

Using the stochastic volatility option pricing model (and notation) of Das and Sundaram (1999) we consider what a two-standard-deviation shock in

detrended trading volume implies for the prices of six-month European options.

Panel A: Options on individual stocks

The benchmark parameters are as follows: stock price P=100, interest rate r=0, annualized long-run variance V

0

=0.16, current variance V=0.16,

mean reversion in variance k=1, and volatility of variance Z=0.4. Firm 1 is assumed to have a value of r=0. Firm 2 is assumed to have a value of

r=À0.38. These values of r imply that the diﬀerence in daily skewness between Firms 1 and 2 is equivalent to that created by a two-standard-devi-

ation move in the DTURNOVER variable, using our baseline ﬁrm-level sample and coeﬃcient estimates from Table 2, col.1.

70 80 90 100 110 120 130

Firm 1: r=0

Six-month European put price 1.197 3.044 6.287 11.082 17.325 24.748 33.044

Black-Scholes implied vol. 40.33% 39.79% 39.50% 39.41% 39.48% 39.67% 39.93%

Firm 2: r=À0.38

Six-month European put price 1.438 3.297 6.419 10.994 17.011 24.282 32.525

Black-Scholes implied vol. 42.50% 41.16% 40.03% 39.10% 38.35% 37.77% 37.34%

Percent increase in put

price: Firm 2 vs. Firm1

20.14% 8.30% 2.09% À0.80% À1.81% À1.88% À1.57%

J

.

C

h

e

n

e

t

a

l

.

/

J

o

u

r

n

a

l

o

f

F

i

n

a

n

c

i

a

l

E

c

o

n

o

m

i

c

s

6

1

(

2

0

0

1

)

3

4

5

–

3

8

1

3

7

6

Panel B: Options on the market portfolio

The benchmark parameters are as follows: stock price P=100, interest rate r=0, annualized long run variance V

0

=0.04, current variance V=0.04,

mean reversion in variance k ¼ 1; and volatility of variance Z ¼ 0:4: Regime 1 is assumed to have a value of r ¼ 0: Regime 2 is assumed to have a value

of r=À0.33. These values of r imply that the diﬀerence in daily skewness between Regimes 1 and 2 is equivalent to that created by a two-standard-

deviation move in the market DTURNOVER variable, using our time-series estimates from Table 7, col. 1.

85 90 95 100 105 110 115

Regime 1: r=0

Six-month European put price 0.859 1.693 3.121 5.330 8.367 12.093 16.298

Black-Scholes implied vol. 20.36% 19.61% 19.09% 18.91% 19.07% 19.49% 20.04%

Regime 2: r=À0.33

Six-month European put price 1.070 1.912 3.258 5.289 8.134 11.755 15.955

Black-Scholes implied vol. 21.84% 20.68% 19.63% 18.76% 18.21% 18.01% 18.10%

Percent increase in put price:

Regime 2 vs. Regime 1

24.66% 12.91% 4.39% À0.77% À2.79% À2.80% À2.10%

J

.

C

h

e

n

e

t

a

l

.

/

J

o

u

r

n

a

l

o

f

F

i

n

a

n

c

i

a

l

E

c

o

n

o

m

i

c

s

6

1

(

2

0

0

1

)

3

4

5

–

3

8

1

3

7

7

statistically much weaker than those from the cross-section, they are no less

indicative of important economic eﬀects.

Although they are not shown in Table 8, we have also done similar

calculations to measure the economic signiﬁcance of our results for past returns.

As it turns out, the quantitative inﬂuence of past returns on skewness is stronger

than that of trading volume. With individual stocks, a shock of 40% to the RET

variable in the most recent six-month period (note from Table 1 that 40% is

approximately a two-standard-deviation shock for a ﬁrm in the next-to-largest

quintile) translates into a movement of 0.087 in the NCSKEW variable. This in

turn is equivalent to r going from zero to À0.920, which causes the put with the

70 strike to rise in value from 1.20 to 1.73, a 44.86% increase.

In the case of the aggregate market, the coeﬃcients on past returns suggest

eﬀects on skewness that are so large that they cannot generally be captured in

the context of a pure diﬀusion model like that of Das and Sundaram (1999).

For example, even if the RET variable has moved by only 7% in the last six

months, one has to adjust r from zero to À0.978 to reﬂect the corresponding

predicted change in NCSKEW. Given that the standard deviation of RET for

the market is about 11%, this means that we cannot even capture a one-

standard-deviation shock to six-month returns without violating the constraint

that the absolute value of r not exceed one. Rather, we are left to conclude

that, for the market as a whole, large movements in past returns give rise to

conditional negative skewness so substantial that it cannot be adequately

represented in terms of a pure diﬀusion process – one would instead need some

type of mixed jump-diﬀusion model.

7. Conclusions

Three robust ﬁndings about conditional skewness emerge from our analysis

of individual stocks. In the cross-section, negative skewness is greater in stocks

that (1) have experienced an increase in trading volume relative to trend over

the prior six months, (2) have had positive returns over the prior 36 months,

and (3) are larger in terms of market capitalization. The ﬁrst two results also

have direct analogs in the time-series behavior of the aggregate market, though

the statistical power of our tests in this case (especially with respect to trading

volume) is quite limited.

Let us try to put each of these ﬁndings into some perspective. The ﬁrst,

regarding trading volume, is the most novel, and is the one we were looking for

based on a speciﬁc theoretical prediction from the model of Hong and Stein

(1999). Clearly, our results here are supportive of the theory. At the same time,

this does not mean that there are not other plausible interpretations. While we

have attempted to control for some of the most obvious alternative stories, no

doubt others can be thought up. This caveat would seem to be particularly

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 378

relevant given that there has been so little research to date on conditional

skewness at the individual stock level.

The second and third ﬁndings, having to do with the eﬀects of past returns

and size on skewness, do not speak directly to predictions made by the Hong-

Stein model. Rather, these variables are included in our regressions because

prior work (Harvey and Siddique, 2000) suggests that they might enter

signiﬁcantly, and we want to be careful to isolate the eﬀects of trading volume

from other factors.

Having veriﬁed the importance of past returns, we have found it helpful to

think about it in terms of models of stochastic bubbles, such as that developed by

Blanchard and Watson (1982). However, we would stop well short of claiming to

have strong evidence in favor of the existence of bubbles. Indeed, there is a large

body of research from the 1980s (see, e.g., reviews by West, 1988; Flood and

Hodrick, 1990) that focuses on a very diﬀerent set of implications of bubble

models – having to do with the relation between prices and measures of

fundamentals such as dividends – and tends to reach mostly skeptical conclusions

on this question. Rather, the more modest statement to be made is that previous

research has not examined the implications of bubble models for conditional

skewness, and that on this one score, the bubble models look pretty good.

With respect to the third ﬁnding – that small-cap stocks are more positively

skewed than large-cap stocks – we are not even aware of an existing theory that

provides a simple explanation. Instead, we have developed an informal

hypothesis after the fact, based on the ideas that (1) managers prefer to disclose

good news right away, while dribbling bad news out slowly, and (2) managers

of small companies have more scope for hiding bad news from the market in

this way. This discretionary-disclosure hypothesis in turn yields the further

prediction that, controlling for size, positive skewness ought to be more

pronounced in stocks with fewer analysts – a prediction which is clearly

supported in the data.

A fair criticism of this whole line of discussion is that we have three main

empirical results, and a diﬀerent theoretical story for each: the Hong-Stein

(1999) model to explain the eﬀect of turnover on skewness, stochastic bubbles to

explain the eﬀect of past returns, and discretionary disclosure to explain the

eﬀect of size. This lack of unity is unsatisfying, and it serves to further

underscore our previous caveat about the extent to which one should at this

point consider any single theory to be strongly supported by the data. A natural

challenge for future work in this area is to come up with a parsimonious model

that captures these three patterns in a more integrated fashion.

References

Almazan, A., Brown, B.C., Carlson, M., Chapman, D.A., 1999. Why constrain your mutual fund

manager?. Working paper, University of Texas, Austin.

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 379

Bakshi, G., Cao, C., Chen, Z., 1997. Empirical performance of alternative option pricing models.

Journal of Finance 52, 2003–2049.

Bates, D., 1991. The crash of ’87: was it expected? The evidence from options markets. Journal of

Finance 46, 1009–1044.

Bates, D., 1997. Post-’87 crash fears in S&P 500 futures options. NBER working paper

5894.

Bekaert, G., Wu, G., 2000. Asymmetric volatility and risk in equity markets. Review of Financial

Studies 13, 1–42.

Black, F., 1976. Studies of stock price volatility changes. Proceedings of the 1976 Meetings of the

American Statistical Association, Business and Economical Statistics Section, 177–181.

Black, F., Scholes, M., 1973. The pricing of options and corporate liabilities. Journal of Political

Economy 81, 637–659.

Blanchard, O.J., Watson, M.W., 1982. Bubbles, rational expectations, and ﬁnancial markets. In:

Wachtel, P. (Ed.), Crises in Economic and Financial Structure. Lexington Books, Lexington,

MA, pp. 295–315.

Braun, P.A., Nelson, D.B., Sunier, A.M., 1995. Good news, bad news, volatility, and betas. Journal

of Finance 50, 1575–1603.

Campbell, J.Y., Hentschel, L., 1992. No news is good news: an asymmetric model of changing

volatility in stock returns. Journal of Financial Economics 31, 281–318.

Christie, A.A., 1982. The stochastic behavior of common stock variances – value, leverage and

interest rate eﬀects. Journal of Financial Economics 10, 407–432.

Coval, J.D., Hirshleifer, D., 1998. Trading-generated news, sidelined investors, and conditional

patterns in security returns. Working paper, University of Michigan Business School, Ann

Arbor.

Damodaran, A., 1987. Information bias: measures and implications. Working paper, New York

University.

Das, S.R., Sundaram, R.K., 1999. Of smiles and smirks: a term structure perspective. Journal of

Financial and Quantitative Analysis 34, 211–239.

DeLong, J.B., Shleifer, A., Summers, L.H., Waldmann, R.J., 1990. Noise trader risk in ﬁnancial

markets. Journal of Political Economy 98, 703–738.

Duﬀee, G.R., 1995. Stock returns and volatility: a ﬁrm-level analysis. Journal of Financial

Economics 37, 399–420.

Dumas, B., Fleming, J., Whaley, R.E., 1998. Implied volatility functions: empirical tests. Journal of

Finance 53, 2059–2106.

Engle, R.F., Ng, V.K., 1993. Measuring and testing the impact of news on volatility. Journal of

Finance 48, 1749–1778.

Fama, E.F., 1998. Market eﬃciency, long-term returns, and behavioral ﬁnance. Journal of

Financial Economics 49, 283–306.

Fama, E.F., MacBeth, J.D., 1973. Risk, return and equilibrium: empirical tests. Journal of Political

Economy 81, 607–636.

Flood, R.P., Hodrick, R.J., 1990. On testing for speculative bubbles. Journal of Economic

Perspectives 4, 85–101.

French, K.R., Schwert, G.W., Stambaugh, R.F., 1987. Expected stock returns and volatility.

Journal of Financial Economics 19, 3–29.

Gallant, A.R., Rossi, P.E., Tauchen, G., 1992. Stock prices and volume. Review of Financial

Studies 5, 199–242.

Genotte, G., Leland, H., 1990. Market liquidity, hedging and crashes. American Economic Review

80, 999–1021.

Glosten, L., Jagannathan, R., Runkle, D.E., 1993. On the relation between the expected

value and the volatility of the nominal excess return on stocks. Journal of Finance 48,

1779–1801.

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 380

Greene, W.H., 1993. Econometric Analysis. Macmillan, New York.

Griﬃn, J.M., Lemmon, M.L., 1999. Does book-to-market equity proxy for distress risk or over-

reaction? Working paper, Arizona State University, Tempe, AZ.

Grossman, S.J., 1988. An analysis of the implications for stock and futures price volatility of

program trading and dynamic hedging strategies. Journal of Business 61, 275–298.

Harris, M., Raviv, A., 1993. Diﬀerences of opinion make a horse race. Review of Financial Studies,

473–506.

Harvey, C.R., Siddique, A., 1999. Autoregressive conditional skewness. Journal of Financial and

Quantitative Analysis 34, 465–487.

Harvey, C.R., Siddique, A., 2000. Conditional skewness in asset pricing tests. Journal of Finance

55, 1263–1295.

Hong, H., Lim, T., Stein, J.C., 2000. Bad news travels slowly: size, analyst coverage and the

proﬁtability of momentum strategies. Journal of Finance 55, 65–295.

Hong, H., Stein, J. C., 1999. Diﬀerences of opinion, rational arbitrage and market crashes. NBER

Working paper.

Jacklin, C.J., Kleidon, A.W., Pﬂeiderer, Paul., 1992. Underestimation of portfolio insurance and

the crash of October 1987. Review of Financial Studies 5, 35–63.

Kandel, E., Pearson, N.D., 1995. Diﬀerential interpretation of public signals and trade in

speculative markets. Journal of Political Economy 103, 831–872.

Koski, J.L., Pontiﬀ, J., 1999. How are derivatives used? Evidence from the mutual fund industry.

Journal of Finance 54, 791–816.

Lakonishok, J., Smidt, S., 1986. Volume for winners and losers: taxation and other motives for

stock trading. Journal of Finance 41, 951–974.

Nelson, D., 1991. Conditional heteroskedasticity in asset returns: a new approach. Econometrica

59, 347–370.

Odean, T., 1998a. Volume, volatility, price and proﬁt when all traders are above average. Journal

of Finance 53, 1887–1934.

Odean, T., 1998b. Are investors reluctant to realize their losses? Journal of Finance 53, 1775–1798.

Pindyck, R.S., 1984. Risk, inﬂation, and the stock market. American Economic Review 74,

334–351.

Poterba, J.M., Summers, L.H., 1986. The persistence of volatility and stock market ﬂuctuations.

American Economic Review 76, 1142–1151.

Romer, D., 1993. Rational asset-price movements without news. American Economic Review 83,

1112–1130.

Schwert, G.W., 1989. Why does stock market volatility change over time? Journal of Finance 44,

1115–1153.

Shefrin, H., Statman, M., 1985. The disposition to sell winners too early and ride losers too long:

theory and evidence. Journal of Finance 40, 777–790.

Varian, H.R., 1989. Diﬀerences of opinion in ﬁnancial markets. In: Stone, C. (Ed.), Financial Risk:

Theory, Evidence and Implications: Proceedings of the 11th Annual Economic Policy

Conference of the Federal Reserve Bank of St. Louis. Kluwer Academic Publishers, Boston,

pp. 3–37.

West, K.D., 1988. Bubbles, fads and stock price volatility tests: a partial evaluation. Journal of

Finance 43, 639–656.

Wu, G., 2000. The determinants of asymmetric volatility. Review of Financial Studies, in

preparation.

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381 381

346

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381

1. Introduction Aggregate stock market returns are asymmetrically distributed. This asymmetry can be measured in several ways. First, and most simply, the very largest movements in the market are usually decreases, rather than increases – that is, the stock market is more prone to melt down than to melt up. For example, of the ten biggest one-day movements in the S&P 500 since 1947, nine were declines.1 Second, a large literature documents that market returns exhibit negative skewness, or a closely related property, ‘‘asymmetric volatility’’ – a tendency for volatility to go up with negative returns.2 Finally, since the crash of October 1987, the prices of stock index options have been strongly indicative of a negative asymmetry in returns, with the implied volatilities of out-of-themoney puts far exceeding those of out-of-the-money calls; this pattern has come to be known as the ‘‘smirk’’ in index-implied volatilities. (See, e.g., Bates, 1997; Bakshi et al., 1997; and Dumas et al., 1998.) While the existence of negative asymmetries in market returns is generally not disputed, it is less clear what underlying economic mechanism these asymmetries reﬂect. Perhaps the most venerable theory is based on leverage eﬀects (Black, 1976; Christie, 1982), whereby a drop in prices raises operating and ﬁnancial leverage, and hence the volatility of subsequent returns. However, it appears that leverage eﬀects are not of suﬃcient quantitative importance to explain the data (Schwert, 1989; Bekaert and Wu, 2000). This is especially true if one is interested in asymmetries at a relatively high frequency, e.g., in daily data. To explain these, one has to argue that intraday changes in leverage have a large impact on volatility – that a drop in prices on Monday morning leads to a large increase in leverage and hence in volatility by Monday afternoon, so that overall, the return for the full day Monday is negatively skewed. An alternative theory is based on a ‘‘volatility feedback’’ mechanism. As developed by Pindyck (1984), French et al. (1987), Campbell and Hentschel (1992), and others, the idea is as follows: When a large piece of good news arrives, this signals that market volatility has increased, so the direct positive eﬀect of the good news is partially oﬀset by an increase in the risk premium. On the other hand, when a large piece of bad news arrives, the direct eﬀect and the risk-premium eﬀect now go in the same direction, so the impact of the news is ampliﬁed. While the volatility-feedback story is in some ways more attractive

1 Moreover, the one increase – of 9.10% on October 21, 1987 – was right on the heels of the 20.47% decline on October 19, and arguably represented a correction of the microstructural distortions that arose on that chaotic day, rather than an independent price change. 2 If, in a discrete-time setting, a negative return in period t raises volatility in period t þ 1 and thereafter, returns measured over multiple periods will be negatively skewed, even if single-period returns are not. The literature on these phenomena includes Pindyck (1984), French et al. (1987), Campbell and Hentschel (1992), Nelson (1991), Engle and Ng (1993), Glosten et al. (1993), Braun et al. (1995), Duﬀee (1995), Bekaert and Wu (2000), and Wu (2001).

J. Chen et al. / Journal of Financial Economics 61 (2001) 345–381

347

than the leverage-eﬀects story, there are again questions as to whether it has the quantitative kick that is needed to explain the data. The thrust of the critique, ﬁrst articulated by Poterba and Summers (1986), is that shocks to market volatility are for the most part very short-lived, and hence cannot be expected to have a large impact on risk premiums. A third explanation for asymmetries in stock market returns comes from stochastic bubble models of the sort pioneered by Blanchard and Watson (1982). The asymmetry here is due to the popping of the bubble – a low-probability event that produces large negative returns. What the leverage-eﬀects, volatility-feedback, and bubble theories all have in common is that they can be cast in a representative-investor framework. In contrast, a more recent explanation of return asymmetries, Hong and Stein (1999), argues that investor heterogeneity is central to the phenomenon. The Hong-Stein model rests on two key assumptions: (1) there are diﬀerences of opinion among investors as to fundamental value, and (2) some – though not all – investors face short-sales constraints. The constrained investors can be thought of as mutual funds, whose charters typically prohibit them from taking short positions; the unconstrained investors can be thought of as hedge funds or other arbitrageurs. When diﬀerences of opinion are initially large, those bearish investors who are subject to the short-sales constraint will be forced to a corner solution, in which they sell all of their shares and just sit out of the market. As a consequence of being at a corner, their information is not fully incorporated into prices. For example, if the market-clearing price is $100, and a particular investor is sitting out, it must be that his valuation is less than $100, but one has no way of knowing by how much – it could be $95, but it could also be much lower, say $50. However, if after this information is hidden, other, previously more-bullish investors have a change of heart and bail out of the market, the originally more-bearish group may become the marginal ‘‘support buyers’’ and hence more will be learned about their signals. In particular, if the investor who was sitting out at a price of $100 jumps in and buys at $95, this is good news relative to continuing to sit on the sidelines even as the price drops further. Thus, accumulated hidden information tends to come out during market declines, which is another way of saying that returns are negatively skewed. With its focus on diﬀerences of opinion, the Hong-Stein model has distinctive empirical implications that are not shared by the representativeinvestor theories. In particular, the Hong-Stein model predicts that negative skewness in returns will be most pronounced around periods of heavy trading volume. This is because – like in many models with diﬀerences of opinion – trading volume proxies for the intensity of disagreement. (See Varian, 1989; Harris and Raviv, 1993; Kandel and Pearson, 1995; and Odean, 1998a for other models with this feature.)

glamour stocks – those with low ratios of book value to market value – are also forecasted to have more negative skewness. but they are perhaps most clearly suggested by models of stochastic bubbles. These control variables can be divided into two categories. the eﬀect of turnover is strongly statistically and economically signiﬁcant. Damodaran. we are not in the business of forecasting negative expected returns.. capture time-varying inﬂuences on skewness. For example. 1997). with their information incompletely revealed in prices. 2000) that skewness is more negative on average for large-cap ﬁrms – a pattern . it has been documented by others (e. In the ﬁrst category are those that. We ﬁnd that when past returns have been high. moreover. at the ﬁrm level. we undertake an empirical investigation that is motivated by this diﬀerences-of-opinion theory. inferred from options prices – as a measure of crash expectations. high past returns or a low book-to-market value imply that the bubble has been building up for a long time. but there is some ability to predict negative skewness based on returns as far back as 36 months. previously more-bullish investors can force the hidden information to come out. (Harvey and Siddique (2000) also examine how skewness varies with past returns and book-to-market. We develop a series of cross-sectional regression speciﬁcations that attempt to forecast skewness in the daily returns to individual stocks. like detrended turnover. / Journal of Financial Economics 61 (2001) 345–381 When disagreement (and hence trading volume) is high. In the context of a bubble model. July 1–December 31. we ask whether the skewness in daily returns measured over a given six-month period (say. 1998) can be predicted from the detrended level of turnover over the prior sixmonth period (January 1–June 30. it is more likely that bearish investors will wind up at a corner. Chen et al. Thus. when the arrival of bad news to other. 1987. The most signiﬁcant variable in this category is past returns. It turns out that ﬁrms that experience larger increases in turnover relative to trend are indeed predicted to have more negative skewness. who also interprets conditional skewness – in his case. In an eﬀort to isolate the eﬀects of turnover. we are adopting a narrow and euphemistic deﬁnition of the word ‘‘crashes.g. This usage follows Bates (1991.’’ associating it solely with the conditional skewness of the return distribution. For example. so that there is a larger drop when it pops and prices fall back to fundamentals. And it is precisely this hiding of information that sets the stage for negative skewness in subsequent rounds of trade. skewness is forecasted to become more negative. our speciﬁcations also include a number of control variables.348 J. Harvey and Siddique. The second category of variables that help to explain skewness are those that appear to be picking up relatively ﬁxed ﬁrm characteristics.) These results can be rationalized in a number of ways. 1998). One of our key forecasting variables is the recent deviation of turnover from its trend. In this paper. The predictive power is strongest for returns in the prior six months. when we speak of ‘‘forecasting crashes’’ in the title of the paper. In a similar vein.

this pure time-series approach entails an enormous loss in statistical power – with data going back to 1962. Given how early it is in this game.S. Here. stock market as a whole. While both the cross-sectional and time-series results for turnover are broadly consistent with the theory we are interested in. Finally. Chen et al. and for which there are no other widely accepted explanations. even if innovations to trading volume proxy for the intensity of disagreement among investors. In Section 3. they likely capture other factors as well – such as changes in trading costs – that we have not adequately controlled for. we attempt to forecast the skewness in the daily returns to the market using detrended market turnover and past market returns. we use an option-pricing metric to evaluate the economic signiﬁcance of our results. First. In addition to running our cross-sectional regressions with the individualﬁrm data. we have less than 70 independent observations of market skewness measured at six-month intervals – which is why it is not the main focus of our analysis. along with a variety of sensitivities and sample splits.J. Obviously. We are not aware of any theories that would have naturally led one to anticipate this ﬁnding. Such a control might be redundant to the extent that detrending the turnover variable already removes ﬁrm eﬀects. we also experiment brieﬂy with analogous time-series regressions for the U. Nevertheless. The remainder of the paper is organized as follows. In Section 4. beyond the eﬀects of turnover. such as ﬁrm size. for our purposes a variable like size is best thought of as an atheoretic control – it is included in our regressions to help ensure that we do not mistakenly attribute explanatory power to turnover when it is actually proxying for some other ﬁrm characteristic. Section 7 concludes. In Section 5. we document other strong inﬂuences on skewness. Rather. we are naturally reluctant to declare an unqualiﬁed victory for any one theory. In Section 6. we review in more detail the theoretical work that motivates our empirical speciﬁcation. and most generally. Second. in which we attempt to forecast the skewness in aggregate-market returns. that are not easily rationalized within the context of the Hong-Stein model. we consider the analogous time-series regressions. our eﬀorts to model the determinants of conditional skewness at the ﬁrm level are really quite exploratory in nature. we should stress that we do not at this point view them as a tight test. / Journal of Financial Economics 61 (2001) 345–381 349 that also shows up strongly in our multivariate regressions. There are several reasons why one might wish to remain skeptical. The coeﬃcient estimates continue to imply economically meaningful eﬀects. it is comforting to note that the qualitative results from the aggregate-market regressions closely parallel those from the cross-sectional regressions in that high values of both detrended turnover and past returns also forecast more negative market skewness. although that for detrended turnover is no longer statistically signiﬁcant. we present our baseline cross-sectional regressions. but we keep it in to be safe. . In Section 2. we discuss our sample and the construction of our key variables.

However. A and B. investor B gets a pessimistic signal. In addition to investors A and B. This deviation from full Bayesian rationality – which can be thought of as a form of overconﬁdence – leads to irreducible diﬀerences of opinion about the stock’s value. This is obviously a lower bound on the fraction of funds that never take short positions. Because of the short-sales constraint. and the only trade will be between investor A and the arbitrageurs. Almazan et al. The arbitrageurs are rational enough to ﬁgure out that B’s signal is below A’s. each investor’s signal contains some useful information. but they cannot know by how much. unconstrained arbitrageurs. each of whom receives a private signal about a stock’s terminal payoﬀ. which provides the principal motivation for our empirical tests. Moreover. the arbitrageurs might be thought of as hedge funds who are not subject to such restrictions. unlike most of the behavioral ﬁnance literature. many of whom are precluded by their charters or operating policies from ever taking short positions. suggesting that funds are also not ﬁnding synthetic ways to take short positions. This is because of the presence of the riskneutral. / Journal of Financial Economics 61 (2001) 345–381 2. the model also incorporates a class of fully rational. As a matter of objective reality. Hence. (1999) document that roughly 70% of mutual funds explicitly state (in Form N-SAR that they ﬁle with the SEC) that they are not permitted to sell short.3 In contrast.350 J. However. the arbitrageurs themselves are not short-sales constrained. the market as a whole is eﬃcient. even if that of the other investor is revealed to them. the model’s only implications are for the higher-order moments of the return distribution. Importantly. so they can take inﬁnitely large positive or negative positions. overconﬁdence). begins with the assumption that there are two investors. each of the two investors only pays attention to their own signal. the arbitrageurs may not always get to see both of the signals. These arbitrageurs recognize that the best estimate of the stock’s true value is formed by averaging the signals of A and B.e. . because A and B face short-sales constraints. Koski and Pontiﬀ (1999) ﬁnd that 79% of equity mutual funds make no use whatsoever of derivatives (either futures or options). so that B’s valuation for the stock lies well below A’s. Chen et al. in the sense of there being no predictability in returns. There are two trading dates. 3 In fact. risk-neutral arbitrageurs. To see how the model can generate asymmetries. B will simply sit out of the market.. Theoretical background The model of Hong and Stein (1999). which relies on limited arbitrage. Even though investors A and B can be said to suﬀer from behavioral biases (i. Perhaps the most natural interpretation of these assumptions is not to take the short-sales constraint literally – as an absolute technological impediment to trade – but rather to think of investors A and B as institutions like equity mutual funds. imagine that at time 1.

There is a countervailing positive-skewness eﬀect at time 1. the ex ante divergence in priors between A and B – which Hong and Stein denote by H – not only governs the extent of negative skewness. Next. when the stock price is falling at time 2. there is information in how B responds to A’s reduced demand for the stock – in whether or not B gets up oﬀ the sidelines and provides buying support. some of B’s previously hidden information might come out.g. the arbitrageurs learn something by observing if and at what price B steps in and starts being willing to buy. Jacklin et al.. It is this unconditional skewness feature – driven by the short-sales constraint – that most clearly distinguishes the model of Hong and Stein from other related models in which pent-up information is revealed through the trading process (e. In this case. 1993). when H is large. while B’s time-1 signal remains hidden. In order to isolate this particular theoretical eﬀect. In particular. it also governs trading volume. trading volume is unusually high at times 1 and 2.. In these other models. Hong and Stein show that if the ex ante divergence of opinion (i.. Chen et al.e. and suppose that A gets a new positive signal. However. so A’s new time-2 signal is incorporated into the price. Genotte and Leland. and variance is greater. the positive time-1 skewness can actually overwhelm the negative time-2 skewness.J. this logic is not suﬃcient to establish that unconditional returns (i.. and Romer. 1990. since the most negative draws of B’s signal are the ones that get hidden from the market at this time. This high trading volume is associated with a greater likelihood of B moving to the sidelines at time 1. 1992. if A gets a bad signal at time 2. On the other hand. returns are on average symmetrically distributed. the average across time 1 and time 2) are negatively skewed. so that returns are on average positively skewed. as opposed to rising. This comparative static result holds regardless of whether unconditional skewness (averaged across diﬀerent values of H) is positive or negative. we need to be aware of other potentially confounding factors. This greater variance on the downside implies that time-2 returns will be negatively skewed. move to time 2. 1988.e. A continues to be the more optimistic of the two. albeit potentially quite volatile. When A’s and B’s priors are suﬃciently close to one another. Moreover. Grossman. and subsequently moving oﬀ the sidelines at time 2 – precisely the mechanism that generates negative skewness. Nevertheless. and it forms the basis for our empirical tests. the time-2 eﬀect dominates. and unconditional returns are negatively skewed. but does not fully reﬂect B’s time-1 signal. the diﬀerence in priors) between A and B is great enough. / Journal of Financial Economics 61 (2001) 345–381 351 Thus the market price at time 1 impounds A’s prior information. it is well known that . In other words. This is because as A bails out of the market at time 2. Thus the comparative statics properties of the model with respect to the parameter H lead to the prediction that increases in trading volume should forecast more negative skewness. For example. Thus more information comes out.

There are a number of models that can deliver such a correlation. Our sample period begins in July 1962. Theoretical models that relate trading volume to diﬀerences of opinion typically assume that transactions costs are zero. To the extent that such an eﬀect is present in our data. past returns might also help predict skewness. all of our regressions include some control for volatility. / Journal of Financial Economics 61 (2001) 345–381 trading volume is correlated with past returns (Shefrin and Statman. To address this concern. Chen et al.. higher levels of volatility are associated with more negative skewness. which is as far back as we can get the trading volume data.e. according to the HongStein model – or whether it is really just forecasting volatility. which is in turn correlated with skewness. and we experiment with several ways of doing this control. and scoresFi. 4 . and In the model of Coval and Hirshleifer (1998). we further truncate the sample by eliminating the very smallest stocks in the NYSE/AMEX universe – in particular. we would like to know whether turnover is forecasting skewness directly – as it should. We do not include NASDAQ ﬁrms because we want to have a uniform and accurate measure of trading volume. there is also conditional negative skewness after periods of positive returns. 1986. even though unconditional average skewness is zero. Lakonishok and Smidt.4 Indeed. Data To construct our variables. primes. closed-end funds. In reality. variations in transactions costs are likely to be an important driver of trading volume. we do not actually begin to forecast returns until December 1965. Odean. And. one might also worry about skewness being correlated with volatility. we begin with data on daily stock prices and monthly trading volume for all NYSE and AMEX ﬁrms. 1998b). for example. and the dealer nature of the NASDAQ market is likely to render turnover in its stocks not directly comparable to that of NYSE and AMEX stocks. stocks that do not have a CRSP share type code of 10 or 11. We do so because our goal is to use trading volume as a proxy for diﬀerences of opinion. those with a market capitalization below the 20th percentile NYSE breakpoint.352 J. because our regressions use many lags. 1985. as noted above. from the CRSP daily and monthly stock ﬁles. In a similar vein. For most of our analysis. REITs. just such a pattern has been documented in recent work by Harvey and Siddique (2000). We also follow convention and exclude ADRs. all of our regressions include a number of lags of past returns on the right-hand side. if there are stochastic bubbles of the sort described by Blanchard and Watson (1982). To control for this tendency. 3. in the volatility-feedback model of Campbell and Hentschel (1992).

as well as any other moments that rely on daily return data. for ‘‘negative coeﬃcient of skewness. Using simple percentage returns instead of log changes does have two (predictable) eﬀects: (1) it makes returns look more positively skewed on average and (2) it induces a pronounced correlation between skewness and contemporaneously measured volatility.’’ is calculated by taking the negative of (the sample analog to) the third moment of daily returns. more precisely. In calculating NCSKEW. We use log changes as opposed to simple daily percentage returns because they allow for a natural benchmark – if stock returns were lognormally distributed. However. and n is the number of observations on daily returns during the period. the daily ﬁrm-level returns that go into the calculation of the NCSKEW variable are market-adjusted returns – the log change in stock i less the log change in the value-weighted CRSP index for that day. actually log changes in price. We also report some sensitivities in which the smallest stocks are analyzed separately (see Table 4 below). / Journal of Financial Economics 61 (2001) 345–381 353 more so for very small stocks.e. Scaling the raw third moment by the standard deviation cubed allows for comparisons across stocks with diﬀerent variances. For most of our regressions. given that we control for volatility in all of our regression speciﬁcations. 1993). we also run everything with variations of NCSKEW based on both (1) excess returns (the log change in stock i less the T-bill return) as well as . the coeﬃcients on turnover for this subsample are noticeably smaller. we hope to raise the ratio of signal (diﬀerences of opinion) to noise (transactions costs) in our key explanatory variable. and as one would expect from this discussion.J. We have also redone everything with an NCSKEW measure based instead on simple daily percentage returns. Our baseline measure of skewness. for any stock i over any six-month period t. this is the usual normalization for skewness statistics (Greene. ð1Þ it it where Rit represents the sequence of de-meaned daily returns to stock i during period t. However. Chen et al. Thus. and dividing it by (the sample analog to) the standard deviation of daily returns raised to the third power. By putting a minus sign in front of the third moment.. having a more left-skewed distribution. we drop any ﬁrm that has more than ﬁve missing observations on daily returns in a given period. we have X 3=2 X NCSKEWit ¼ À nðn À 1Þ3=2 R3 ðn À 1Þðn À 2Þ R2 . which we denote NCSKEW. then an NCSKEW measure based on log changes should have a mean of zero. using simple percentage returns does not materially alter the coeﬃcients on turnover and past returns. These daily ‘‘returns’’ are. and none of our main results are aﬀected. By eliminating the smallest stocks. we are adopting the convention that an increase in NCSKEW corresponds to a stock being more ‘‘crash prone’’ – i.

but has little predictive power beyond that.g. Chen et al. The choice of a six-month horizon for measuring skewness is admittedly somewhat arbitrary. but there is little payoﬀ to doing so. For example. however.’’ is computed as follows. the eﬀects that we are interested in could be playing themselves out over a shorter horizon. In particular. Again. our results with NCSKEW and DUVOL are for the most part quite similar. and hence is less likely to be overly inﬂuenced by a handful of extreme days. In all cases. respectively. As will be seen. we also work with a second measure of return asymmetries that does not involve third moments. we separate all the days with returns below the period mean (‘‘down’’ days) from those with returns above the period mean (‘‘up’’ days). for ‘‘down-to-up volatility. March 1–August 31 and September 1–February 28. We have. This alternative measure. the convention is that a higher value of this measure corresponds to a more leftskewed distribution. our choice to use six months’ worth of daily returns to estimate skewness is driven more by measurement concerns. ð2Þ ðnd À 1Þ DOWN UP where nu and nd are the number of up and down days. this is particularly relevant given that a higher-order moment like . we use nonoverlapping six-month observations on skewness. Unfortunately. statistical power becomes a real issue. In addition to NCSKEW. if we estimated skewness using only one month’s worth of data. For any stock i over any six-month period t. which we denote by DUVOL. When we turn to the timeseries regressions with aggregate-market data. we already have more than enough statistical power as it is. so that we would have a new skewness measure every month. etc. checked our results by re-running everything using diﬀerent nonoverlapping intervals – e. as will become clear shortly. February 1–July 31 and August 1–January 31.354 J. the model of Hong and Stein does not give us much guidance in this regard. In our regressions with ﬁrm-level data. In principle. To preview. / Journal of Financial Economics 61 (2001) 345–381 (2) beta-adjusted returns. the results are essentially identical. since. Lacking this theoretical guidance. Thus we have ( !) X X 2 2 DUVOLit ¼ log ðnu À 1Þ Rit Rit . We could alternatively use overlapping data. so it does not appear that they depend on a particular parametric representation of return asymmetries. these variations do not make much diﬀerence to our results with NCSKEW. so that trading volume on Monday forecasts skewness for the rest of the week. and compute the standard deviation for each of these subsamples separately. We then take the log of the ratio of (the sample analog to) the standard deviation on the down days to (the sample analog to) the standard deviation on the up days.. and we use overlapping observations. the NCSKEW and DUVOL measures are calculated using data from either January 1–June 30 or July 1–December 31 of each calendar year. we would presumably have more measurement error.

we want to eliminate any component of turnover that can be thought of as a relatively ﬁxed ﬁrm characteristic.e. (2) ﬁve size-based subsamples. / Journal of Financial Economics 61 (2001) 345–381 355 skewness is strongly inﬂuenced by outliers in the data. In Panels B and C. the other variables that we use are very familiar and do not merit much discussion. is that to the extent that our measurement horizon does not correspond well to the underlying theory.e. it makes little sense to require that ﬁrm eﬀects be literally constant over the entire sample period. Table 1 presents a variety of summary statistics for our sample. SIGMA and RET are based on excess returns as well. deﬁned as the value-weighted NYSE/AMEX index. positive mean values of NCSKEW and DUVOL – for the market as a whole. Chen et al. LOGSIZEit is the log of ﬁrm i ’s stock market capitalization at the end of period t: BK/MKTit is ﬁrm i ’s book-to-market ratio at the end of period t: LOGCOVERit is the log of one plus the number of analysts (from the I/B/E/S database) covering ﬁrm i at the end of period t: TURNOVERit is the average monthly share turnover in stock i. Instead. When we compute NCSKEW or DUVOL using excess returns. which are positively skewed. Again. which we denote DTURNOVER.. and (3) the market as a whole. Since we have such a long time series. This detrending is roughly analogous to doing a ﬁxed-eﬀects speciﬁcation in a shorter-lived panel. SIGMA and RET are computed using market-adjusted returns.. (When working with the market as a whole. deﬁned as shares traded divided by shares outstanding over period t: In our baseline speciﬁcation. as noted above. This discrepancy can in principle be understood within the strict conﬁnes of the Hong-Stein model. the model . also measured over the six-month period t: When we compute NCSKEW or DUVOL using either market-adjusted or betaadjusted returns. as in most of our subsequent regression analysis. however. all the variables are based on simple excess returns relative to T-bills. respectively. the rationale for doing this detrending is that. we work with detrended turnover. the detrending controls for ﬁrm characteristics that adjust gradually. we restrict the sample to those ﬁrms with a market capitalization above the 20th percentile NYSE breakpoint. measured over the six-month period t: RETit is the cumulative return on stock i. The important point to note. for the sample of individual ﬁrms. as a matter of conservatism. Besides the skewness measures.) Panels B and C look at contemporaneous correlations and autocorrelations. Panel A shows the means and standard deviations of all of our variables for (1) the full sample of individual ﬁrms. the opposite is true for individual stocks. it should make our tests too conservative. One interesting point that emerges from Panel A is that while there is negative skewness – i. this should simply blur our ability to ﬁnd what the theory predicts – i. by subtracting from the TURNOVER variable a moving average of its value over the prior 18 months. since. The detrending is done very simply. SIGMAit is the standard deviation of stock i ’s daily returns.J.

RETt is the market-adjusted cumulative return in the six-month period t. which is measured starting in December 1976. measured using market-adjusted returns in the six-month period t. SIGMAt is the standard deviation of (daily) marketadjusted returns measured in the six-month period t. À0. measured using market-adjusted returns in the six-month period t.171 0.139 0. BK=MKTt is the most recently available observation of the book-to-market ratio at the end of period t. Chen et al.476 0. TURNOVERt is the average monthly turnover measured in the six-month period t.362 0.172 0.964 À0.437 À0.190 0.923 À0.128 0. Size quintiles are determined using NYSE breakpoints. Quintile 5 (largest) ﬁrms Quintile 4 ﬁrms Quintile 3 ﬁrms Quintile 2 ﬁrms Quintile 1 (smallest) ﬁrms Market portfolio All ﬁrms Panel A: First and second moments NCSKEWt Mean Standard dev.262 0.213 0. / Journal of Financial Economics 61 (2001) 345–381 Table 1 Summary statistics The sample period is from July 1962 to December 1998.266 0. DTURNOVERt is average monthly turnover in the six-month period t.356 J. LOGSIZEt is the log of market capitalization measured at the end of period t.141 0. DUVOLt is the log of the ratio of down-day to up-day standard deviation.904 À0.436 À0.806 À0.406 À0. NCSKEWt is the negative coeﬃcient of (daily) skewness.198 0.939 À0.224 0.364 À0. DUVOLt Mean Standard dev.994 À0.377 .391 À0.155 0. detrended by a moving average of turnover in the prior 18 months.268 0.735 0. except for LOGCOVERt. LOGCOVERt is the log of one plus the number of analysts covering the stock at the end of period t.

249 1. of obs. LOGSIZEt Mean Standard dev.642 0.924 0.001 0.018 5.055 0.054 0.202 14.017 0.983 14.503 0.177 2.030 0.029 0. Chen et al.710 2.055 0.040 0.023 0.036 1.431 0.988 0.008 0.512 0.073 0.007 6. BK/MKTt Mean Standard dev.010 4.564 0.050 0.508 À0.472 3.563 0. 0. RETt Mean Standard dev.039 0.121 1.984 0.991 0.037 0. No.653 0.019 0.000 0. TURNOVERt Mean Standard dev.060 0.046 0.005 0.920 1.291 0.727 0.015 0.656 0.000 0.043 0.372 41.005 8.035 0.824 0.108 1.002 0.002 0.020 0.164 13.860 0.288 16.275 22.025 0.023 3.056 0.006 0.022 0.651 0.066 0.015 0.075 0.001 0.021 0.SIGMAt Mean Standard dev. DTURNOVERt Mean Standard dev.063 0.034 0.870 2.003 0.002 0.017 0.003 N/A J.098 À0.840 0.782 0.008 5. / Journal of Financial Economics 61 (2001) 345–381 357 N/A N/A 0.935 1.050 0.051 0.140 0.240 14.297 100.024 0.197 1.095 0.667 0.565 0.241 0.108 421 .898 0. LOGCOVERt Mean Standard dev.042 0.

023 0.068 À0.257 À0.022 0. Chen et al.061 DUVOLtÀ1 SIGMAtÀ1 LOGSIZEtÀ1 BK=MKTtÀ1 LOGCOVERtÀ1 DTURNOVERtÀ1 TURNOVERtÀ1 RETtÀ1 Panel C: Autocorrelations and cross-correlations (using only ﬁrms above 20th percentile in size) NCSKEWt DUVOLt SIGMAt LOGSIZEt BK/MKTt LOGCOVERt DTURNOVERt TURNOVERt RETt 0.006 À0.976 À0.104 À0.043 0.045 À0.030 .047 0.027 0.119 0.342 À0.090 À0.049 0.068 À0.032 0. / Journal of Financial Economics 61 (2001) 345–381 NCSKEWt DUVOLt SIGMAt LOGSIZEt BK/MKTt LOGCOVERt DTURNOVERt TURNOVERt RETt NCSKEWtÀ1 0.056 À0.166 À0.130 0.056 0.852 0.719 À0.026 0.050 À0.022 0.019 0.130 0.086 0.729 À0.181 0.294 À0.195 À0.008 À0.028 À0.292 0.039 0.158 À0.047 À0.066 À0.042 À0.063 0.022 0.218 0.307 0.238 0.017 0.014 0.032 À0.016 0.028 À0.213 0.007 À0.035 0.076 0.398 0.302 À0.008 0.013 0.736 0.009 0.067 À0.042 0.047 0.052 0.079 0.055 0.782 À0.318 0.011 À0.098 À0.014 À0.093 0.013 0.011 À0.061 À0.000 0.079 À0.080 0.064 0.371 0.100 À0.101 À0.059 0.071 0.002 0.015 À0.047 À0.182 0.133 0.059 0.038 0.781 À0.030 À0.028 0.002 0.109 0.006 À0.311 0.875 0.376 0.381 0.715 À0.006 0.358 Table 1 (continued) NCSKEWt DUVOLt SIGMAt LOGSIZEt BK/MKTt LOGCOVERt DTURNOVERt TURNOVERt RETt Panel B: Contemporaneous correlations (using only ﬁrms above 20th percentile in size) J.034 0.104 0.024 0.179 À0.026 À0.013 0.081 0.080 À0.051 0.042 À0.029 0.

We pool all the data (excluding ﬁrms with market capitalization below the 20th percentile NYSE breakpoint) and regress NCSKEWit+1 against its own lagged value. and six lags of past returns. Baseline speciﬁcation Table 2 presents our baseline cross-sectional regression speciﬁcation. it must be missing something when it comes to explaining the mean skewness of individual stocks.01. We also include dummy variables . For NCSKEW the autocorrelation is on the order of 0. The most noteworthy fact in Panel B of Table 1 is the contemporaneous correlation between our two skewness measures. Forecasting skewness in the cross-section 4. In other words. without further embellishments. depending on the degree of ex ante investor heterogeneity. as well as SIGMAit.1. Nevertheless. While these two measures are quite diﬀerent in their construction. Chen et al. these low correlations lend some preliminary (and comforting) support to the notion that forecasting either of our skewness measures is a quite distinct exercise from forecasting volatility.05. DTURNOVERit. the theory will certainly gain some credence if it does a good job of explaining cross-sectional variation in skewness.88. they appear to be picking up much the same information. even if it cannot ﬁt the mean skewness at the ﬁrm level. it is not clear that such an assumption is empirically defensible. RETit yRETitÀ5. 4.J.09.72 – neither of our skewness measures has much persistence. However. NCSKEWit. An alternative interpretation of the data in Table 1A is that even if the Hong-Stein model provides a reasonable account of skewness in market returns. NCSKEW and DUVOL. if one is willing to assume that diﬀerences of opinion about the market are on average more pronounced than diﬀerences of opinion about individual stocks. This view does not imply that we cannot learn something about the theory by looking at ﬁrm-level data. it is worth emphasizing the caveat that. for DUVOL it is 0. and that between DUVOL and SIGMA is about À0. the theory might not provide a convincing rationale for everything that is going on at the individual stock level. Panel C documents that. it might be that large positive events like hostile takeovers (which the theory ignores) impart an added degree of positive skewness to individual stocks but wash out across the market as a whole. LOGSIZEit.08. unlike SIGMA – which has an autocorrelation coeﬃcient of 0. For example. / Journal of Financial Economics 61 (2001) 345–381 359 allows for either positive or negative unconditional skewness. Also worth pointing out is that the correlation between NCSKEW and SIGMA is less than 0. the model can produce negative skewness for the latter and positive skewness for the former. which is 0.

053 (3. t-statistics.426 0.370 (À5.082 (4.462) 0.110) 0. Chen et al. (1) Base case: market-adjusted returns NCSKEWt SIGMAt LOGSIZEt DTURNOVERt RETt RETtÀ1 RETtÀ2 RETtÀ3 RETtÀ4 RETtÀ5 No.441) À3.051 (7.053 (7. are adjusted for heteroskedasticity and serial correlation.218 (10.041 (2.706) 0.220) 0.092 (5.403) 0.129) 0.759) 51.638) 0.778) À4.046 (13.103 (5.465) 0.329) 0.920) À2.058 (3.257) 51. All regressions also contain dummies for each time period (not shown).242) 0.175) 0.180) 0.089 (5.052 (7. detrended by a moving average of turnover in the prior 18 months.426 0.566 (À7. The dependent variable is NCSKEWtþ1 .030 (2) Beta-adjusted returns 0.054 (2. RETtyRETtÀ5 are returns in the six-month periods t through t À 5 (these past returns are market adjusted in cols. 1–3.197 (9.675) 0.108 (5.839) 0.497) 0.071 (3. beta-adjusted returns and simple excess returns in cols.067 (3.175) 0.059 (19. SIGMAt is the (daily) standard deviation of returns in the six-month period t: LOGSIZEt is the log of market capitalization at the end of period t: DTURNOVERt is average monthly turnover in the six-month period t. of obs.082 (4.701 (À4.437 (3. respectively.426 0.149) 0. 1À2 and excess in col.360 J.701) 0.082 for each time period t: The regression can be interpreted as an eﬀort to predict – based on information available at the end of period t – cross-sectional variation in skewness over period t þ 1: .607) 0. which are in parentheses. the negative coeﬃcient of (daily) skewness in the six-month period t þ 1: NCSKEWtþ1 is computed based on market-adjusted returns.221 (11.477) 0. / Journal of Financial Economics 61 (2001) 345–381 Table 2 Forecasting skewness in the cross-section: pooled regressions The sample period is from July 1962 to December 1998 and includes only those ﬁrms with market capitalization above the 20th percentile breakpoint of NYSE.031 (3) Excess returns 0.001) 0.335) 51.133) 0.296) 0.364 (3.109 (6.083 (4. 3).062 (3. R2 0.830) 0.364 (3.037 (11.

a measure analogous to what we use here. the ﬁndings for past returns and size run broadly parallel to previous work by Harvey and Siddique (2000).e. they may try to delay its release. suggesting that negative skewness is more likely in large-cap stocks. Nevertheless. such results were by no means a foregone conclusion. as in Harvey and Siddique (2000). For 25 portfolios sorted on size and book-to-market. what is the correlation of the two skewness measures? The answer is about 0. and (2) the average skewness of daily individual stock returns. The coeﬃcient on size is also positive. correlation. In particular. (We expect lower coeﬃcient estimates when using simple excess returns as compared to market-adjusted returns – after all. so it should have more ability to explain skewness in the purely idiosyncratic component of stock returns. ours are couched in a multivariate regression framework. But more signiﬁcantly. while they look at portfolios of stocks. it is possible to come up with rationalizations after the fact. Thus. for two reasons. First. the positive coeﬃcient on size is not something one would have necessarily predicted ex ante based on the Hong-Stein model. while they look at monthly returns. we look at daily returns.) The past return terms are also always positive and strongly signiﬁcant. As noted above. to become more crash-prone. especially if. It seems plausible that if they uncover good news. To begin. We have done some detailed comparisons to make these latter points explicit. if they are sitting on bad news. we look at individual stocks. while theirs are based on univariate sorts. as Harvey and Siddique (2000) stress. and in column 3 we use simple excess returns. while it might have been reasonable to conjecture – based on the prior evidence in Harvey and Siddique (2000) – that our ﬁrm-level NCSKEW variable would also be related to past returns and size. Second. a relatively low.J. our measure of skewness is quite diﬀerent from theirs. The skewness of a portfolio of stocks is not the same thing as the average skewness of its component stocks. As we have already stressed. The results are quite similar in all three cases.22. all else equal. the coeﬃcients on detrended turnover are positive and strongly statistically signiﬁcant in each of the three columns. In contrast. DTURNOVER is a ﬁrm-speciﬁc variable. We can then ask the following: Across the 25 portfolios. we use market-adjusted returns as the basis for computing the NCSKEW measure. albeit signiﬁcantly positive. we have computed both (1) the skewness of monthly portfolio returns. albeit somewhat larger (by about 20%) in magnitude when market-adjusted returns are used. / Journal of Financial Economics 61 (2001) 345–381 361 In column 1. there are several distinctions between our results and theirs. Chen et al.. In column 2 we use beta-adjusted returns. they will disclose all this good news right away. with the result that the . Suppose that managers can to some extent control the rate at which information about their ﬁrms gets out. coskewness varies systematically with ﬁrm characteristics. Nevertheless. Thus stocks that have experienced either a surge in turnover or high past returns are predicted to have more negative skewness – i.

TURNOVER. we are essentially removing our ﬁxed-eﬀect control from the turnover variable. we truncate outliers of the NCSKEW variable. In other words. one might expect that long-run cross-ﬁrm variation in turnover would also predict skewness – some ﬁrms might be subject to persistently large diﬀerences in investor opinion. In columns 3 and 4. This has little impact on the results. and showing up in the regression only because SIGMAit+1 is correlated with NCSKEWit+1. This means that we are now admitting into consideration diﬀerences in turnover across ﬁrms that are not merely temporary deviations from trend but more in the nature of long-run ﬁrm characteristics. Moreover. and use it to develop some additional testable implications. or whether it is instead forecasting SIGMAit+1. and uses an NCSKEW measure based on market-adjusted returns.2. if one adds the further assumption that it is easier for managers of small ﬁrms to temporarily hide bad news – since they face less scrutiny from outside analysts than do managers of large ﬁrms – the resulting positive skewness will be more pronounced for small ﬁrms. Chen et al. roughly doubling in magnitude from its base-case value. 4. Recall that the central issue here is whether DTURNOVERit is really forecasting NCSKEWit+1 directly. suggesting that they are not driven by a handful of outlier observations. we investigate whether our results are somehow tied to the way that we have controlled for volatility. We return to this idea in Section 4. we are throwing out a dimension of the data that is strongly supportive of the theory. in column 1 of Table 3.5 below. Everything is a variation on column 1 of Table 2. so that we can verify that DTURNOVERit is still signiﬁcant even after the inclusion of this control. This behavior will tend to impart positive skewness to ﬁrm-level returns. / Journal of Financial Economics 61 (2001) 345–381 bad news dribbles out slowly. This implies that our ﬁxed-eﬀect approach of using DTURNOVER instead of TURNOVER everywhere else in the paper is quite conservative – in doing so. In column 2. Ideally. Robustness In Table 3 we conduct a number of further robustness checks. First. The coeﬃcient estimate on TURNVOVER in column 2 conﬁrms this notion.362 J. and may explain why returns on individual stocks are on average positively skewed at the same time that market returns are negatively skewed. setting all observations that are more than three standard deviations from the mean in any period t to the threestandard-deviation tail values in that period. we replace the DTURNOVER variable with its un-detrended analog. we would like to add a period-t control variable to the regression that is a good forecast of SIGMAit+1. Our use of SIGMAit in the base-case speciﬁcation can be motivated on the grounds that it is probably the best . According to the theory. and these too should matter for return asymmetries.

given the very pronounced serial correlation in the SIGMA variable. based on the following information set available in period t: SIGMAit. are more crash-prone. SIGMAitÀ1. we also experiment with allowing two coeﬃcients on SIGMAit. Finally. These two lags are insigniﬁcant. this variation leads to almost exactly the same results as in the base case. we allow this eﬀect to be a function of the realization of NCSKEWit itself. Overall. DTURNOVERit. SIGMAitÀ2. This variation (not shown in the table) makes no diﬀerence to the results. Chen et al. This variable attracts a signiﬁcant negative coeﬃcient. In column 5. but is instrumented using the information available in period t: As can be seen. we conclude that it is highly unlikely that our base-case success in forecasting NCSKEW with the DTURNOVER and RET variables arises because these variables are able to forecast SIGMA. (1993). Motivated by the work of Glosten et al. we check to make sure our results are robust to how we have modeled the eﬀect of the lagged skewness variable. Although the diﬀerence in units precludes a direct comparison of the point estimates. the qualitative patterns are generally the same as in the corresponding speciﬁcation in column 1 of Table 2. the addition of BK/MKT has no impact on the DTURNOVER coeﬃcient. we add the book-to-market ratio. 3. one for positive past returns and one for negative past returns.0%). .J. Instead of estimating just one coeﬃcient on NCSKEWit.7% vs. these variables really appear to be predicting cross-ﬁrm diﬀerences in the asymmetry of stock returns. based on the evidence in columns 3 and 4 of Table 3. / Journal of Financial Economics 61 (2001) 345–381 363 univariate predictor of SIGMAit+1. We then replace SIGMAit in the base case with this ﬁtted value of future volatility. the t-statistic on DTURNOVER is actually a bit higher (4. In this spirit. One can presumably do better by allowing for richer dynamics. NCSKEWit. rather than just diﬀerences in volatility. we add in column 3 two further lags of SIGMA (SIGMAitÀ1 and SIGMAitÀ2) to the base-case speciﬁcation. In column 6. Indeed. We implement this by interacting NCSKEWit with ﬁve dummy variables. in an unreported sensitivity. SIGMAHATit+1. we use the DUVOL measure of return asymmetry as the lefthand-side variable in place of NCSKEW. who ﬁnd that the eﬀect of past volatility on future volatility depends on the sign of the past return. In other words.35 vs. 3. and RETit yRETitÀ5. LOGSIZEit. which means that it tells the same story as the past-return terms: glamour stocks.84) as is the R2 of the regression (6. which we denote by SIGMAHATit+1. to the base-case speciﬁcation. In column 4 we take our logic one step further. We create a ﬁtted value of SIGMAit+1. and hence our coeﬃcients on DTURNOVERit as well as on the six RET terms are virtually unchanged. This is equivalent to an instrumental-variables regression in which future volatility SIGMAit+1 is included on the right-hand side. like those with high past returns. However. BK/MKT. But using just one past lag is not necessarily the best way to forecast SIGMAit+1.

051 (7.014 (9. are adjusted for heteroskedasticity and serial correlation.999 (À7.938) À6.956 (À15.033 (9.353) 0.RETtÀ5 : All regressions also contain dummies for each time period (not shown).572) 0..384) À0. DTURNOVERt. Chen et al. SIGMAtÀ2 . In columns 1–5. returns are market-adjusted.037 (10.053 (7.837) (3) More lags of past volatility 0. 6) SIGMAHATtþ1 SIGMAt SIGMAtÀ1 SIGMAtÀ2 LOGSIZEt BK/MKTt 0.751) À0. except in column 3.035 (10.034 (9. the negative coeﬃcient of (daily) skewness in the six-month period t þ 1: In column 6.822) À3.953 (À3. SIGMAt is the standard deviation of (daily) returns in the six-month period t: LOGSIZEt is the log of market capitalization at the end of period t: BK/MKTt is the most recently available observation of the book-to-market ratio at the end of period t: DTURNOVERt is average monthly turnover in the six-month period t.627) J. t-statistics.180) À4. the dependent variable is NCSKEWtþ1 .808) 0.367 (À0.020 (À3.675) (2) Turnover not detrended 0.047) 0.178 (À7. RETtyRETtÀ5 are returns in the six-month periods t through t À 5: SIGMAHATtþ1 is the predicted value of SIGMAtþ1 calculated from a regression of SIGMAtþ1 on SIGMAt.994 (À8. LOGSIZEt.053 (7.460 (À0.663) (4) Fitted future volatility 0.552) À4.050 (8.351) 0.035 (12. the dependent variable is DUVOLtþ1 .618 (À9.054 (7.096 (16. the log of the ratio of down-day to up-day standard deviation in the six-month period t þ 1: In all columns.. (1) Outliers truncated NCSKEWt (DUVOLt in col.364 Table 3 Forecasting skewness in the cross-section: robustness checks The sample period is from July 1962 to December 1998 and includes only those ﬁrms with market capitalization above the 20th percentile breakpoint of NYSE.980) À4. detrended by a moving average of turnover in the prior 18 months. which are in parentheses. and RETt.095) À0.698) (5) Book-tomarket 0. / Journal of Financial Economics 61 (2001) 345–381 .454) À6.y.898) 0.750) (6) Using DUVOLt+1 0. where turnover is not detrended.

051 (2.014 (1.848) 0.734) 0.671) 0.206 (11.142 (15.229 0.213 (10.073 (3.075 (4.729) 0.249) 0.054 (2.039 0.083 (4.009 (1. of obs. Chen et al.048 (3.621) 0.828) 0.287) 0.038) 0.057 (3.041 (2.049 (3.375 (3.030 0.030) 0.426 0.630 0.100 (6.411 (3.587) 0.523) 0.071 (3.580) 51.081 (4.087) 0.810) 0.045 (5.705) 51.426 0.820) 51.071) 0.056 (2.472) 0.887) 0.217 (10.131) 0.014 (1.587) 0.031 0.387 (3.060 (3.685) 0.098 (5.727) 0.054 (2.324) 48.943) 0.030 0.273) 0.033 (1.722) 0.787) 0.106 (5.819) 0.218 (10.808) 0.064 (3.202 (4.104 (5.030 0.067 J.761) 0.072 (3.208 (10.789) 51.066 (3.410) 0.088 (4.816) 0. R 2 0.337) 0.426 0. / Journal of Financial Economics 61 (2001) 345–381 365 .329) 0.428) 0.923) 52.056 (2.393 0.DTURNOVERt (TURNOVERt in col.455 (3.014 (1.346) 0. 2) RETt RETtÀ1 RETtÀ2 RETtÀ3 RETtÀ4 RETtÀ5 No.084) 0.084 (4.761 (7.459) 0.

albeit still positive. As we have emphasized. Thus. 6 Several recent papers ﬁnd that predictability – based on either ‘‘momentum’’ or ‘‘value’’ strategies – is stronger in small-cap stocks (see. / Journal of Financial Economics 61 (2001) 345–381 one corresponding to each quintile of NCSKEWit. we disaggregate our base-case analysis by size. the coeﬃcients look reasonably stable.g. 4. There is certainly no hint that the eﬀects that we are interested in go away for larger ﬁrms. we are reluctant to hazard an economic interpretation for these anomalies.366 J. 1998. The fact that the coeﬃcients on DTURNOVER are robust for large ﬁrms is not surprising in light of the underlying theory. Indeed.. and the coeﬃcients on the past-return terms are smaller and much less signiﬁcant. the model does not have the feature that the key eﬀects diminish as one moves to larger stocks. whereas our theory requires a good proxy for diﬀerences of opinion.. Hong et al.5 Again.g.) Two conclusions stand out. Fama. 2000. In other words. Second. the coeﬃcient on DTURNOVER for the smallest category of ﬁrms is noticeably lower than for any other group. we estimate ﬁve separate slope coeﬃcients on lagged skewness. 1990) whose implications for return predictability are often thought of as applying more forcefully to small stocks. the model of Hong and Stein is not predicated on impediments to arbitrage – it incorporates a class of fully risk-neutral arbitrageurs who can take inﬁnite long or short positions. This is in contrast to behavioral models based on limited arbitrage (e. where arbitrage activity is presumably more eﬃcient. as suspected. the highest point estimate for the DTURNOVER coeﬃcient comes from the next-to-largest quintile. the coeﬃcient on SIGMA changes signs. these nonlinearities do not at all impact the coeﬃcients on any of the other variables of interest. depending on the quintile that lagged skewness falls in.. We take the speciﬁcation from column 1 of Table 2 and run it separately for ﬁve size-based subsamples. corresponding to quintiles based on NYSE breakpoints. 1999). (Recall that in Tables 2 and 3.g. and Griﬃn and Lemmon. as long as some investors other than the arbitrageurs (e. Given the potential distortions associated with infrequent trading and price discreteness for this group. once one moves beyond the smallest quintile.3. e. this is probably because variation in turnover for these tiny ﬁrms is driven in large part by variation in trading costs. . DeLong et al. As it turns out. we omit the smallest of these ﬁve quintiles from our sample. First.. Chen et al.6 5 Also for these smallest ﬁrms.. Cuts on ﬁrm size In Table 4. while there appear to be some modest nonlinearities in the eﬀect of lagged skewness. mutual funds) continue to be short-sales constrained.

554) 0.014 (0. Chen et al.053 (3.045 (5.010 (À0.690) À4.021) 0.335 (7.128 (2.215) 0.816) 0.535) 0.078 (1.014 (0.028 4.047 (1.906) 12.758) À3.010 (0.341) À4.450) 0.134 (4. R2 0.404 (1.059 (3.855) 0.503) 12.001 (0.554) 0.864) À0.726) 0. SIGMAt is the standard deviation of (daily) returns in the six-month period t: LOGSIZEt is the log of market capitalization at the end of period t: DTURNOVERt is average monthly turnover in the six-month period t.298) 0.101 (2.653) À4.771) 0.359) 0.013 (0.155 (4.035 Quintile 4 ﬁrms 0.076) 0. Stability over subperiods In Table 5.750 0.083 (2.852) 0. of obs.054 (4.165 0.264 (1.112) 0.024 Quintile 2 ﬁrms 0. Speciﬁcally.029 Quintile 1 (smallest) ﬁrms 0.894 (8. The dependent variable in all columns is NCSKEWtþ1 .639) 0.749 0.465) 13.105 (3.025 (0. t-statistics are adjusted for heteroskedasticity and serial correlation.362 (À2. we run a separate.033 (1.024) 0.043 (3.263) 0.823) 0.043 (À1.682) 0.000) 0.632) 29.801) 12. purely cross-sectional variant of the regression in column 1 of Table 2 for every one of .260 (5.431) 2. using a Fama-MacBeth (1973) approach.800) 0.551 (2. the negative coeﬃcient of (daily) skewness in the six-month period t þ 1: In all columns.612) 0.243) 0.793) 0.071 (1.682) 0.069 (2. RETtyRETtÀ5 are returns in the six-month periods t through t À 5: All regressions also contain dummies for each time period (not shown). we examine the intertemporal stability of our baseline regression.269) 0.066 (8.104 (2.030 Quintile 3 ﬁrms 0.134 (3.334) 0.072) 0.4.637) 0.540) 0.651) 0.590) 0.163 (3.162 (3.017 (1. returns are market-adjusted.391) 0. Firm size cuts are based on NYSE breakpoints.006 (0.049 (1.093 (2.062 (À4.215 (5.637) 0.569) 0.165 (3.009 (1.079 (1. detrended by a moving average of turnover in the prior 18 months.812) 0.009) 0.089 (1.028 (1. Quintile 5 (largest) ﬁrms NCSKEWt SIGMAt LOGSIZEt DTURNOVERt RETt RETtÀ1 RETtÀ2 RETtÀ3 RETtÀ4 RETtÀ5 No.J.407 0.157) 0.409 (À3. / Journal of Financial Economics 61 (2001) 345–381 Table 4 Forecasting skewness in the cross-section: cuts by ﬁrm size 367 The sample period is from July 1962 to December 1998.520 0.637 (2.057 (1.

368 J.730 0.464 0.757 2.145 0.517) À9.955 À0. the negative coeﬃcient of (daily) skewness in the six-month period t þ 1: In all cases.061) 0.040 (2.026 À0. detrended by a moving average of turnover in the prior 18 months.913 À0.062 0.835 0.381 All periods 1990s Panel B: Average coeﬃcients by subperiods NCSKEWt 0.334 À0.258) 2. returns are market-adjusted.161 0.207 0.099 (2.577 (À2.383 1.173) À11.024 (1.372 1.776) 0.182 À0.498 6/1970 12/1970 6/1971 12/1971 6/1972 12/1972 6/1973 12/1973 6/1974 12/1974 6/1975 12/1975 6/1976 12/1976 6/1977 12/1977 6/1978 12/1978 6/1979 12/1979 0. The speciﬁcation is the same as in col. RETtyRETtÀ5 are returns in the six-month periods t through t À 5: Panel A reports only the coeﬃcient on DTURNOVERt for each period.901 0.507 (À3. and the associated t-statistics.404 À0.121 À0.803 0.248 À0. 1960s 1970s 1980s 1990s Panel A: Period-by-period regressions (12/1965 to 6/1998). SIGMAt is the standard deviation of (daily) returns in the six-month period t: LOGSIZEt is the log of market capitalization at the end of period t: DTURNOVERt is average monthly turnover in the six-month period t.941 0.079 (4.257 0.210 Late 1960s 6/1980 12/1980 6/1981 12/1981 6/1982 12/1982 6/1983 12/1983 6/1984 12/1984 6/1985 12/1985 6/1986 12/1986 6/1987 12/1987 6/1988 12/1988 6/1989 12/1989 1970s 1.156 À0.314 0.643 0.904 2.569 0.373 2. coeﬃcient on detrended turnover only 12/1965 6/1966 12/1966 6/1967 12/1967 6/1968 12/1968 6/1969 12/1969 0.016 0.218 1.030 (4.038 1980s 6/1990 12/1990 6/1991 12/1991 6/1992 12/1992 6/1993 12/1993 6/1994 12/1994 6/1995 12/1995 6/1996 12/1996 6/1997 12/1997 6/1998 1.780 À0.876 1.579 À0.407 (0.269 0.672 0.200) SIGMAt LOGSIZEt . and adjusted for serial correlation.981 0.880) À5.884 (À1.222) 0.707 À0.686 0.448 À0.194 1.081 0.973 1.459 0. based on the time-series standard deviations of the coeﬃcients. Panel B reports the mean coeﬃcients for diﬀerent subperiods.506 0.288) 0.101 0.388 0. Chen et al.918 1.141) 0.512 1.017 (À2.363 À0.027 (2.065 0.063 (4.029 À0.468 1.063) 0.545 2.005 (0.201 0.631 1. The dependent variable is NCSKEWtþ1 .064 (2.216) 0.751 0. / Journal of Financial Economics 61 (2001) 345–381 Table 5 Forecasting skewness in the cross-section: Fama-MacBeth approach The sample period is from July 1962 to December 1998 and includes only those ﬁrms with market capitalization above the 20th percentile breakpoint of NYSE.614) 0. 1 of Table 2.312) 0.083 0.053 0.129 0.058 0.707) À3.148 À0.738 0.032 (4.

645) 0.549) 0. the 1980s. In Panel B. Given that .133 (2. Chen et al.357) 0.017 (0.323) 0.014) 20 1980s 0.335 (1.104 (1.532 over the full sample period – reaches a low of 0.592 in the 1970s.887) 0.807) 0.098) 0.044 (0.967) 66 Late 1960s 0.132 (2.663) 0.326) 0.497 (2. Moreover.492) 17 369 RETt RETtÀ1 RETtÀ2 RETtÀ3 RETtÀ4 RETtÀ5 No.5.222 (3.085 (1.909) 0.592 (2.684) 0. 4.056 (1.524) 0.081 (2. we show time-averages of all the regression coeﬃcients for the full sample and for each of four decade-based subperiods: the 1960s.193) 20 1990s 0.057 (0.091 (1.099 (3. / Journal of Financial Economics 61 (2001) 345–381 Table 5 (continued) All periods DTURNOVERt 0.341) 0.390) 0.229 (3.372) 0. the 1970s.427) 0.139 (2.555) 0. and compute the associated t-statistics based on the time-series properties of the coeﬃcients (and adjusting for serial correlation).917) 0.139 (4. The overriding conclusion that emerges from Table 5 is that our results are remarkably stable over time.071 (1.387) 0.242 (2.036 (0.767) 9 1970s 0.452) 0. We then take simple time-averages of the cross-sectional regression coeﬃcients over various subperiods.136 (1.532 (3.565 (2.486 in the 1980s and a high of 0.614) 0.596) 0. the 66 six-month periods in our sample.280) 0. Why are small stocks more positively skewed? One of the most striking patterns that we have documented is that small stocks are more positively skewed than large stocks.082 (1.026 (0.132 (2.229 (1.234 (3. In Panel A of Table 5.453) 0.838) 0. even taken alone.981) 0.100 (1. and the 1990s.249 (6.045 (0. three of the four decade-based subperiods produce a statistically signiﬁcant result for DTURNOVER.082 (2.513) 0. we display the coeﬃcient on DTURNOVER from every one of the 66 regressions.J.711) 0.312) 0. of obs.139 (1.486 (1.287) 0. the coeﬃcient on DTURNOVER – which averages 0. For example.

. Thus it may be asking too much to expect that the results here will be strongly statistically signiﬁcant in their own right.) The coeﬃcients on LOGCOVER have the predicted positive sign. Speciﬁcally. Chen et al. if there is more scope for such managerial discretion in small ﬁrms – perhaps because they face less scrutiny from security analysts – then the positive-skewness eﬀect will be more pronounced in small stocks. this idea is outside the main scope of the paper. and prefer to announce good news immediately. while allowing bad news to dribble out slowly. 5. Forecasting market skewness We now turn to forecasting skewness in the returns to the aggregate market. we at least have a plausible explanation for what would otherwise be a puzzling feature of our data. The one satisfying thing about this after-the-fact hypothesis is that it yields new testable predictions. As described above. positive skewness ought to be greater in ﬁrms with fewer analysts. 7 After developing the discretionary-disclosure hypothesis. Nevertheless. he also ﬁnds that ﬁrms with fewer analysts have more positively skewed returns. (The sample period in Table 6 is shorter.370 J. we became aware of a closely related working paper by Damodaran (1987). and that as a result. our statistical power is severely limited. / Journal of Financial Economics 61 (2001) 345–381 this pattern is not clearly predicted by any existing theories (of which we are aware) we have had to come up with a new hypothesis after the fact in order to rationalize it. Moreover. one might more reasonably hope that they look qualitatively similar to those from the cross-sectional regressions. but remain signiﬁcant as well. and are strongly statistically signiﬁcant. Table 6 investigates this prediction. this hypothesis begins with the assumption that managers have some discretion over the disclosure of information. rather. and pursuing it more seriously would take us too far aﬁeld. taking our baseline speciﬁcations for both NCSKEW and DUVOL. We do not mean to cast Table 6 as a deﬁnitive test of the discretionary-disclosure hypothesis.7 The coeﬃcients on LOGSIZE go down a bit. it is comforting to know that the most obvious auxiliary prediction of the hypothesis is borne out in the data. This behavior tends to impart a degree of positive skewness to returns. and running the regressions in Table 6. Using data from 1979 to 1983. While this is in many ways the more interesting exercise from an economic viewpoint. after controlling for size. since analyst coverage is not available from I/B/E/S prior to December 1976. and in each case adding LOGCOVER. the log of one plus the number of analysts covering the stock. Nothing else changes.

RETtyRETtÀ5 are returns in the six-month periods t through t À 5: All regressions also contain dummies for each time period (not shown). of obs.945) À4. 1 is NCSKEWtþ1 .992) 0.140) 0.135 (12.025 Our deﬁnition of the aggregate market is the value-weighted NYSE-AMEX index. 2 it is DUVOLtþ1 .767) 0. and all returns are excess returns relative to T-bills.012 (1. LOGCOVERt is the log of one plus the number of analysts covering the stock at the end of period t.705) 40.090 (13.586) 0.219 (8.290) 0.288) 0. t-statistics are adjusted for heteroskedasticity and serial correlation.032 (7. To avoid any temptation to further mine the data. DTURNOVERt is average monthly turnover in the six-month period t.665) 0.599) 0.649) À3.188 (À4.253) 0.683) 0. LOGSIZEt is the log of market capitalization at the end of period t.681) 0. Chen et al.044) 0.504) 0.085 (3.564) 0. detrended by a moving average of turnover in the prior 18 months.049 (6. (1) Using NCSKEWtþ1 measure NCSKEWt (DUVOLt in col. The dependent variable in col.493) 40.2) SIGMAt LOGSIZEt DTURNOVERt LOGCOVERt RETt RETtÀ1 RETtÀ2 RETtÀ3 RETtÀ4 RETtÀ5 No.011 (6.688 0.040 (4.100 (4.410) 0.059) 0.006 (0.065 (3.504 (3.648) 0.006 (0.006 (3. / Journal of Financial Economics 61 (2001) 345–381 Table 6 Forecasting skewness in the cross-section: adding analyst coverage 371 The sample period is from December 1976 to December 1998 and includes only those ﬁrms with market capitalization above the 20th percentile breakpoint of the NYSE. and in col.051 0.022 (À11. the negative coeﬃcient of skewness in the six-month period t þ 1.J.019 (4.366) 0.055 (2. we use essentially the same speciﬁcation as . the log of the ratio of down-day to up-day standard deviation in the six-month period t þ 1: SIGMAt is the standard deviation of (daily) returns in the six-month period t. R 2 (2) Using DUVOLtþ1 measure 0.010 (1.688 0.058 (2.207 (3.

The six past-return terms are always positive. Chen et al. The one drawback with these data is that we cannot use them to literally calculate turnover. In light of this power problem. since they give only the number of shares traded and not the number of shares outstanding. respectively. it shares the common element that lagged skewness helps to forecast future skewness. except for LOGSIZE and the time dummies. and again run the regression with and without October 1987. Thus we cannot 8 Harvey and Siddique (1999) build an autoregressive conditional skewness model for aggregatemarket returns. and run the regressions with and without October 1987. the point estimates suggest large quantitative eﬀects relative to the cross-sectional regressions. We lose 30 observations because we do not allow any observation on NCSKEW. we also re-run our regressions omitting October 1987. The basic story is the same in all four columns. a new concern that arises with the time-series approach is the extent to which our inferences are dominated by the enormous daily movements during October 1987. The DTURNOVER variable is constructed exactly as before. the DTURNOVER variable in any given month draws on 24 months’ worth of data. To address this concern. Because of the detrending. (1992). while their speciﬁcation is very diﬀerent from that here. SIGMA. the coeﬃcient on DTURNOVER.) This yields a total of 401 observations that can be used in the regressions. In an eﬀort to get the most out of the little time-series data that we have. while positive in each of the four regressions. Dropping October 1987 seems to increase the precision of the DTURNOVER coeﬃcient estimate somewhat. the coeﬃcients on DTURNOVER and the RET terms are now on the order of ten times bigger than they were in the previous tables. This brings us down to 371 observations. / Journal of Financial Economics 61 (2001) 345–381 in our baseline cross-sectional analysis.8 Speciﬁcally. DUVOL. who in turn take it from the S&P Security Price Record. but the highest t-statistic across the four speciﬁcations is only 1. we now use monthly overlapping observations. In contrast. In columns 1 and 2 we use the NCSKEW measure of skewness. (The t-statistics we report are adjusted accordingly. we obtained an alternative series on NYSE volume going back to 1928 from Gallant et al.15. Thus both turnover and past returns could well be very important for forecasting the skewness of market returns. Indeed. In columns 3 and 4 we use the DUVOL measure of skewness. Nevertheless.9 The results are summarized in Table 7.372 J. holding statistical signiﬁcance aside. we use all the same righthand-side variables. 9 . by detrending TURNOVER with its own moving average over the prior 18 months. or DTURNOVER to enter the regression if it draws on data from October 1987. is never statistically signiﬁcant. However. and many are individually statistically signiﬁcant. but we lack the statistical power to assert these conclusions – particularly regarding turnover – with much conﬁdence.

217 (0. the log of the ratio of down-day to up-day standard deviation in the six-month period t þ 1: SIGMAt is the standard deviation of (daily) market returns in the six-month period t: DTURNOVERt is the average monthly turnover of the market portfolio in the six-month period t. excluding 10/87 0.708 (0.184 (3.647 (4.596 (1.443 (0.855) 18. the negative coeﬃcient of skewness in the six-month period t þ 1. variable is NCSKEWtþ1 .589 (0.147) 1.221 (1. variable is DUVOLtþ1 . 3 and 4 it is DUVOLtþ1 .842) 1. t-statistics.844) À3. of obs.926 (1.3 and 4) SIGMAt DTURNOVERt RETt RETtÀ1 RETtÀ2 RETtÀ3 RETtÀ4 RETtÀ5 No.148) 1.386 (1. R 2 (2) Dep.749) 9.930) 371 0. The dependent variable in cols.274 0.357) 0.156) 6.809 (4. (1) Dep.968) 0.326) 401 0.475 (1.406) 1. 1 and 2 is NCSKEWtþ1 .123 (1.602) 1.100 (0.484 (4. variable is NCSKEWtþ1 NCSKEWt (DUVOLt in col.265 quite reproduce our baseline speciﬁcations for the longer post-1928 sample period. and in cols.554 (1.939) 0.680 (1.481) 0.828) 1.017 (0.325) 0.196 (0.704) 1. are adjusted for heteroskedasticity and serial correlation.283 (2.462 (1.349 (0.686 (2.242) 0.898) 0. Chen et al. which are in parentheses.574 (À0. RETtyRETtÀ5 are returns in the six-month periods t through t À 5.332 (1.049) 0.187 (2.264 (3) Dep.086) 1.753) 371 0.137) 6. detrended by a moving average of turnover in the prior 18 months.398) 0. Nevertheless.287 (0.922) 0.300) 9.232) 13.473 (2.264) 1.304 (4) Dep.470 (1. .061) 0. we get results for this sample period that are very similar to those reported in Table 7.J. excluding 10/87 0.726) 0. where the market is deﬁned as the value-weighted portfolio of all NYSE/AMEX stocks.288) 401 0.168) 0. variable is DUVOLtþ1 0.126 (0.077 (2.324 (0.183 (1. using detrended values of raw trading volume to approximate detrended turnover.262) 2.575) 0. / Journal of Financial Economics 61 (2001) 345–381 Table 7 Forecasting skewness in the market: time-series regressions 373 The sample period is from July 1962 to December 1998 and is based on market returns in excess of the risk-free rate.734) 0.585 (3.002 (0.482 (1.

Economic signiﬁcance of the results: an option-pricing metric Thus far. and have not really asked whether they imply magnitudes that are economically meaningful. Vt is the current variance. we have focused on the statistical signiﬁcance of our results. Chen et al. with a correlation coeﬃcient of r: The parameter r is the one of central interest for our purposes. k is the mean reversion parameter for the variance process.. The idea behind our metric can be understood as follows. If we are willing to ﬁx all the other parameters besides r. The two Wiener processes dz1 and dz2 are instantaneously correlated. 1=2 ð3Þ dz2 . How much does the left-hand-side variable – NCSKEW or DUVOL – move? What makes things diﬃcult here is that most people have little sense for what would constitute an economically interesting change in NCSKEW or DUVOL. In order to map the parameters of the option-pricing model into our NCSKEW variable. these .e. we need to (1) ﬁnd an optionpricing model that admits skewness in returns and (2) create a mapping from the parameters of this model to our NCSKEW variable. / Journal of Financial Economics 61 (2001) 345–381 6. ð4Þ dVt ¼ kðV0 À Vt Þdt þ ZVt where pt is the log of the stock price. To help frame things in a way that is hopefully more intuitive. The model we use is the stochastic-volatility model of Das and Sundaram (1999). we can translate statements about NCSKEW into statements about the prices of outof-the-money put options. As a result. Now the stock experiences a surge in turnover. as it governs the skewness of stock returns: when r=0. when ro0. Given this new forecast of NCSKEW – but holding volatility ﬁxed – by how much does the value of the put option increase? To answer this sort of question precisely. you revise your forecast of NCSKEW. V0 is the long-run mean level of variance. and Z is the volatility of the variance process. Imagine that you are pricing an out-of-the-money put on a stock whose returns you initially believe to be symmetrically distributed – i. log returns are symmetrically distributed. Assessing economic signiﬁcance in the current context is a bit tricky. log returns are negatively skewed. a stock for which you believe that NCSKEW is equal to zero. in which the dynamics of stock prices are summarized by the following two diﬀusion equations: dpt ¼ a dt þ Vt 1=2 dz1 .374 J. a is the expected return on the stock. we draw on formulas given by Das and Sundaram that express the skewness in daily log returns as a function of the diﬀusion parameters. DTURNOVER – is shocked by two standard deviations. The thought experiment that is typically undertaken is something like this: suppose that the right-hand-side variable of interest – in this case. using the DTURNOVER coeﬃcient estimate from our regressions.

223) this value of skewness in daily returns for ﬁrm 2 can be shown to imply r=À0.437=0. Panel B then compares the prices of six-month European puts across two regimes. which has symmetrically distributed returns – i.86 in regime 1 but 1. Once we have obtained the implied value of r in this way. and the riskless rate r=0.005 (see Table 1A). except that we now set V0 ¼ Vt ¼ 0:04.) We also set the stock price P=100. the ﬁrm 1 put has a Black-Scholes (1973) implied volatility of 40.36% and 21. Panel A of Table 8 displays the impact of this change in r for the prices of six-month European put options.07 in regime 2.20 for ﬁrm 1 but 1.66%. a two-standard-deviation shock to DTURNOVER translates into a movement of 0. the standard deviation of DTURNOVER is 0. Or expressed in a diﬀerent way. where the parameters are chosen so as to be reasonable for individual stocks: k=1. corresponding to an annual standard deviation of returns of 20%. and from Table 2. This is equivalent to a value of r=0. For example. The standard deviation of DTURNOVER (for ﬁrms above the 20th percentile NYSE breakpoint) is 0. column 1. it calculates put prices for both ﬁrm 1 (which has NCKSEW=0 and thus r=0) and ﬁrm 2 (which has NCSKEW=0.06 for NCSKEW is equivalent to r=À0. Using the coeﬃcient estimate on DTURNOVER of 6. we take ﬁrm 2. Vt =0.e. Next. We keep all the diﬀusion parameters the same as in Panel A.042. Using Eq. Panel B undertakes a similar experiment to gauge the signiﬁcance of our time-series results. an increase of 24. an increase of 20.38. p. Chen et al. except that it has a two-standard-deviation higher value of DTURNOVER. a put with a strike price of 85 is worth 0.16 corresponds to an annual standard deviation of returns of 40%. the diﬀerences appear to be meaningful. Once again. For the market as a whole.037). and Z ¼ 0:4: (Setting the variance V to 0.84%. which is identical to ﬁrm 1. the impact on put prices is substantial.037 and thus r=À0. assuming all the other diﬀusion parameters stay ﬁxed.J. the coeﬃcient on DTURNOVER is 0. Table 8 illustrates the results of this exercise. respectively. That is.037 (2 Â 0. V0 =0. the ﬁrst with r=0 and the second with r=À0. Consider ﬁrst Panel A.33.33.14%.16. we can calculate options prices and thereby see the impact of a given value of NCSKEW.00 from Table 7.16.38).042 Â 0. a put with a strike of 70 is worth 1.33%. Given the other diﬀusion parameters.06 in the NCSKEW variable.44 for ﬁrm 2. particularly if one goes relatively far out-of-the-money. this value of 0.. Hence the value of NCSKEW for ﬁrm 2 is 0. while the ﬁrm 2 put has an implied volatility of 42. The corresponding implied volatilities are 20. These results reinforce a point made above: while the time-series estimates are . We begin with a hypothetical ﬁrm 1. As can be seen. (21) in Das and Sundaram (1999. For example. it has NCSKEW=0.437.50%. / Journal of Financial Economics 61 (2001) 345–381 375 formulas allow us to ask to what value of r a given value of NCSKEW corresponds. column 1.

Firm 1 is assumed to have a value of r=0. current variance V=0.88% 32.80% 17.1.79% 6. Percent increase in put price: Firm 2 vs.77% À1.438 42.10% À0.525 37. Firm 2 is assumed to have a value of r=À0.082 39.16.044 39.011 38. Firm 2: r=À0.376 J.325 39.38.38 Six-month European put price Black-Scholes implied vol.419 40.044 39.287 39. Panel A: Options on individual stocks The benchmark parameters are as follows: stock price P=100.67% 33.14% 3. col. and volatility of variance Z=0.93% 80 90 100 110 120 130 .03% 2.50% 11.50% 20. These values of r imply that the diﬀerence in daily skewness between Firms 1 and 2 is equivalent to that created by a two-standard-deviation move in the DTURNOVER variable.33% 3.4.282 37. / Journal of Financial Economics 61 (2001) 345–381 Table 8 Economic signiﬁcance of trading volume for skewness in stock returns: an option-pricing metric Using the stochastic volatility option pricing model (and notation) of Das and Sundaram (1999) we consider what a two-standard-deviation shock in detrended trading volume implies for the prices of six-month European options.09% 10.16.297 41.30% 6.34% À1.748 39. using our baseline ﬁrm-level sample and coeﬃcient estimates from Table 2. Firm1 1.57% 1.35% À1.81% 24.41% 17. Chen et al. interest rate r=0.16% 8.48% 24. mean reversion in variance k=1. 70 Firm 1: r=0 Six-month European put price Black-Scholes implied vol. annualized long-run variance V0=0.197 40.994 39.

21% À2.68% 12.912 20.39% 5.298 20. / Journal of Financial Economics 61 (2001) 345–381 377 . These values of r imply that the diﬀerence in daily skewness between Regimes 1 and 2 is equivalent to that created by a two-standarddeviation move in the market DTURNOVER variable.258 19. annualized long run variance V0=0. Chen et al.49% 16. Regime 1 1.07% 12.91% 8. 1.36% 1.33.84% 24.755 18.134 18.76% À0.66% 1.33 Six-month European put price Black-Scholes implied vol.289 18.070 21.330 18.04.04. using our time-series estimates from Table 7. mean reversion in variance k ¼ 1. 85 Regime 1: r=0 Six-month European put price Black-Scholes implied vol.61% 3.955 18.77% 8.121 19. current variance V=0.04% 90 95 100 105 110 115 J. interest rate r=0.91% 3. col.859 20.367 19.80% 15.093 19.10% 0.Panel B: Options on the market portfolio The benchmark parameters are as follows: stock price P=100.09% 5.79% 11. and volatility of variance Z ¼ 0:4: Regime 1 is assumed to have a value of r ¼ 0: Regime 2 is assumed to have a value of r=À0.01% À2.693 19.63% 4. Regime 2: r=À0.10% À2. Percent increase in put price: Regime 2 vs.

978 to reﬂect the corresponding predicted change in NCSKEW. we have also done similar calculations to measure the economic signiﬁcance of our results for past returns.73. no doubt others can be thought up. Although they are not shown in Table 8. we are left to conclude that. This caveat would seem to be particularly . regarding trading volume.86% increase. As it turns out. The ﬁrst. In the case of the aggregate market. a 44. even if the RET variable has moved by only 7% in the last six months. Rather. While we have attempted to control for some of the most obvious alternative stories.087 in the NCSKEW variable. this does not mean that there are not other plausible interpretations. large movements in past returns give rise to conditional negative skewness so substantial that it cannot be adequately represented in terms of a pure diﬀusion process – one would instead need some type of mixed jump-diﬀusion model. 7. for the market as a whole. Clearly. Chen et al. For example. is the most novel. In the cross-section. the coeﬃcients on past returns suggest eﬀects on skewness that are so large that they cannot generally be captured in the context of a pure diﬀusion model like that of Das and Sundaram (1999). Conclusions Three robust ﬁndings about conditional skewness emerge from our analysis of individual stocks. (2) have had positive returns over the prior 36 months. this means that we cannot even capture a onestandard-deviation shock to six-month returns without violating the constraint that the absolute value of r not exceed one. and (3) are larger in terms of market capitalization. which causes the put with the 70 strike to rise in value from 1. negative skewness is greater in stocks that (1) have experienced an increase in trading volume relative to trend over the prior six months. the quantitative inﬂuence of past returns on skewness is stronger than that of trading volume. though the statistical power of our tests in this case (especially with respect to trading volume) is quite limited. our results here are supportive of the theory. At the same time. they are no less indicative of important economic eﬀects. This in turn is equivalent to r going from zero to À0. one has to adjust r from zero to À0. Let us try to put each of these ﬁndings into some perspective.920. a shock of 40% to the RET variable in the most recent six-month period (note from Table 1 that 40% is approximately a two-standard-deviation shock for a ﬁrm in the next-to-largest quintile) translates into a movement of 0. The ﬁrst two results also have direct analogs in the time-series behavior of the aggregate market. Given that the standard deviation of RET for the market is about 11%. and is the one we were looking for based on a speciﬁc theoretical prediction from the model of Hong and Stein (1999). With individual stocks.378 J.20 to 1. / Journal of Financial Economics 61 (2001) 345–381 statistically much weaker than those from the cross-section.

. With respect to the third ﬁnding – that small-cap stocks are more positively skewed than large-cap stocks – we are not even aware of an existing theory that provides a simple explanation. controlling for size. This discretionary-disclosure hypothesis in turn yields the further prediction that. we have developed an informal hypothesis after the fact. these variables are included in our regressions because prior work (Harvey and Siddique. the more modest statement to be made is that previous research has not examined the implications of bubble models for conditional skewness. we have found it helpful to think about it in terms of models of stochastic bubbles. we would stop well short of claiming to have strong evidence in favor of the existence of bubbles. Indeed. and (2) managers of small companies have more scope for hiding bad news from the market in this way. References Almazan. A fair criticism of this whole line of discussion is that we have three main empirical results. Having veriﬁed the importance of past returns. stochastic bubbles to explain the eﬀect of past returns. and it serves to further underscore our previous caveat about the extent to which one should at this point consider any single theory to be strongly supported by the data. / Journal of Financial Economics 61 (2001) 345–381 379 relevant given that there has been so little research to date on conditional skewness at the individual stock level. Rather. e.. D.. Flood and Hodrick. and discretionary disclosure to explain the eﬀect of size. while dribbling bad news out slowly.. and a diﬀerent theoretical story for each: the Hong-Stein (1999) model to explain the eﬀect of turnover on skewness. having to do with the eﬀects of past returns and size on skewness. The second and third ﬁndings.A. A natural challenge for future work in this area is to come up with a parsimonious model that captures these three patterns in a more integrated fashion. do not speak directly to predictions made by the HongStein model. and we want to be careful to isolate the eﬀects of trading volume from other factors. the bubble models look pretty good. B. M.g. . A. Rather. positive skewness ought to be more pronounced in stocks with fewer analysts – a prediction which is clearly supported in the data. there is a large body of research from the 1980s (see. However. Instead.C. 1999.. such as that developed by Blanchard and Watson (1982). Chen et al. University of Texas. Working paper. 2000) suggests that they might enter signiﬁcantly. based on the ideas that (1) managers prefer to disclose good news right away. Brown. This lack of unity is unsatisfying. and that on this one score. Chapman.J. Carlson. Why constrain your mutual fund manager?. 1988. 1990) that focuses on a very diﬀerent set of implications of bubble models – having to do with the relation between prices and measures of fundamentals such as dividends – and tends to reach mostly skeptical conclusions on this question. reviews by West. Austin.

1–42. G. Hentschel. Summers. The pricing of options and corporate liabilities. 177–181.. Braun. Working paper. 1976. Tauchen. P.F.D. Shleifer. Journal of Finance 53.R.F. 1973. Journal of Political Economy 81..W. and betas... Z.R. 1997. J. A.. R. 1982. Post-’87 crash fears in S&P 500 futures options. 2000.. 1992. 1999. Information bias: measures and implications. French.. Crises in Economic and Financial Structure. B. Working paper.F.. R.B. H. Black. 999–1021. 1997. Cao. Blanchard. 1779–1801. and conditional patterns in security returns. 1993. E. Journal of Finance 46. Coval. D. Nelson. Market liquidity..380 J. 1998. Trading-generated news. Proceedings of the 1976 Meetings of the American Statistical Association. Campbell. 1995.F. 295–315. Studies of stock price volatility changes. Risk. Bates. Wu. No news is good news: an asymmetric model of changing volatility in stock returns. 1995. Flood. F..R. V. and behavioral ﬁnance. Good news. A. Christie. P. M.. 407–432. Journal of Economic Perspectives 4. Stock returns and volatility: a ﬁrm-level analysis. In: Wachtel. Asymmetric volatility and risk in equity markets. 1993. J. Scholes. P. 85–101.. Lexington.. 2059–2106. Journal of Finance 48... Runkle. New York University. Noise trader risk in ﬁnancial markets. F.J. G. O.. Sunier. Damodaran. A. 211–239. R. Journal of Finance 52. 2003–2049. A. Bubbles. Journal of Political Economy 81. Duﬀee. The stochastic behavior of common stock variances – value.. Whaley... MA. D. L. On testing for speculative bubbles. Fama. pp. leverage and interest rate eﬀects. Waldmann. G. 637–659.. rational expectations. sidelined investors.. G. Measuring and testing the impact of news on volatility. Hodrick. 283–306.. K.. NBER working paper 5894. Engle. J.. Business and Economical Statistics Section. L. American Economic Review 80. R. 1998. Ng. 1575–1603. R.... Stambaugh. R. S. 399–420.. 1987.. C. Fleming. return and equilibrium: empirical tests. Journal of Financial Economics 19. Empirical performance of alternative option pricing models. Hirshleifer. Schwert. 1973. Gallant. Journal of Political Economy 98. J. J. Market eﬃciency. Leland...D.. Watson. / Journal of Financial Economics 61 (2001) 345–381 Bakshi. 1987. D. Expected stock returns and volatility. (Ed.A. Bekaert. Journal of Financial and Quantitative Analysis 34. G.M.J.. Chen et al. 1992. Journal of Financial Economics 49. D. Journal of Finance 48. E. 1009–1044. A. Journal of Financial Economics 10. Das. Black. Journal of Finance 50.. 703–738. Fama. Journal of Financial Economics 37. Lexington Books.B. Stock prices and volume... Review of Financial Studies 5. 1990.Y. Chen. D. On the relation between the expected value and the volatility of the nominal excess return on stocks. 607–636. L.. Dumas. Of smiles and smirks: a term structure perspective. R.E.). G. University of Michigan Business School.. 1991. The crash of ’87: was it expected? The evidence from options markets. long-term returns. DeLong....A.J. .K. R. Journal of Financial Economics 31.. Ann Arbor. Rossi. 1998.. G. 3–29... 1749–1778. M. MacBeth.P. 199–242. 1990.. Bates. Jagannathan. 1982. and ﬁnancial markets.. 1990.H. volatility..E.. Review of Financial Studies 13. bad news.E. Implied volatility functions: empirical tests.W. Sundaram. Genotte.R. 281–318. hedging and crashes. Glosten.K.

Odean. 1989.. Tempe. 1998a. Journal of Finance 55. Pﬂeiderer. Hong. K.W. The persistence of volatility and stock market ﬂuctuations. A. Bad news travels slowly: size. Koski. Hong. Why does stock market volatility change over time? Journal of Finance 44. H. 35–63. Odean. 1995....R. 65–295..J. 1999.R.. in preparation.. Smidt. 1985. 1992. Conditional heteroskedasticity in asset returns: a new approach.M.. M. .. inﬂation. (Ed. Boston. Poterba.. Paul. Lim. Are investors reluctant to realize their losses? Journal of Finance 53. C. M.. Grossman. The determinants of asymmetric volatility.. Journal of Finance 40. Shefrin. D. 1989. 2000.. Stein. Review of Financial Studies 5. Journal of Finance 54. An analysis of the implications for stock and futures price volatility of program trading and dynamic hedging strategies. and the stock market. rational arbitrage and market crashes. 1986. Volume.. Pindyck. A... Harvey. Econometric Analysis. Rational asset-price movements without news.. Diﬀerential interpretation of public signals and trade in speculative markets. 1115–1153.. 1993. J. W. C. analyst coverage and the proﬁtability of momentum strategies. A. Risk.S. Statman. 1984. Conditional skewness in asset pricing tests. Siddique. J.. 473–506. Nelson. American Economic Review 83. 1999. Econometrica 59. 639–656. Wu.. American Economic Review 74. Underestimation of portfolio insurance and the crash of October 1987. 3–37. 1988. J.C. Lemmon. Journal of Business 61. 1142–1151. 1988.. Arizona State University. S. Pontiﬀ. J.). Evidence and Implications: Proceedings of the 11th Annual Economic Policy Conference of the Federal Reserve Bank of St. T.L. How are derivatives used? Evidence from the mutual fund industry. Does book-to-market equity proxy for distress risk or overreaction? Working paper. H. Journal of Political Economy 103. 2000.H. Review of Financial Studies.. Journal of Finance 41. price and proﬁt when all traders are above average. Journal of Financial and Quantitative Analysis 34. T.D. Harris. 347–370. Journal of Finance 55. Varian. The disposition to sell winners too early and ride losers too long: theory and evidence. 1993. 1887–1934.M. 275–298. 1998b. 777–790.W. Griﬃn. 1991. 1112–1130. 1986.. 1999. G. J. New York. Harvey. Kluwer Academic Publishers. 1263–1295. Kandel. Diﬀerences of opinion make a horse race.. A. Bubbles. M.D.. Diﬀerences of opinion. C. Chen et al.J. Siddique. Autoregressive conditional skewness. Diﬀerences of opinion in ﬁnancial markets. West. 1993... R. AZ.H.R.. 334–351.. Review of Financial Studies.. Louis... Summers.. Pearson.J. 2000. H. C. 1999. J. J. Macmillan. NBER Working paper. 465–487. Stein. Kleidon. L. American Economic Review 76. C. Financial Risk: Theory. D.. S. Jacklin. Romer. 1775–1798. In: Stone. 951–974. Journal of Finance 43... G. pp. Lakonishok. E.. H. T. Journal of Finance 53. 791–816. Volume for winners and losers: taxation and other motives for stock trading. Raviv. 831–872. / Journal of Financial Economics 61 (2001) 345–381 381 Greene. Schwert. fads and stock price volatility tests: a partial evaluation.L. volatility. N.

Ocular Issues and Endocrine Diseases in Small Animal Practice (Canine Eye Disease)

Medication Strategies for Muscle Pain

Cornell Study on Employee Engagement

DOD First Aid Book

Financial Analysts Handbook

CBOT Handbook

CCI System for Trading Stocks (Commodity Channel Index)

1 Minute Daily Trading Strategy

Lessons From the Financial Crisis of 2008

Treasury Report on the Financial Crisis

Treasury Report on the Financial Crisis

- Read and print without ads
- Download to keep your version
- Edit, email or read offline

Mehmood Hussain Syed

Article written by Mehmood H Syed, about AAPL stock, where a future change in...

Stock Market Forecasting by Multivariate Higher Order Fuzzy Time Series Model

Forecasting Uk Stock Market.

Stock Market Forecasting - Using Time & Price Cycles - AAPL Forecast

2010 Stock Market Forecast

Forecasting Stock Market Volatility Using Nonlinear) Garch Models

Oaktree Liquidity Letter

Using Garch Forecast Different in Stock Markets

Stock Market Index Forecasting Model Using the GARCH Tool.

Neural Prediction of Weekly Stock Market Index(1)

3 Indicators I Use to Predict Stock Market Bottoms

Using Garch Forecast Different in Stock Markets

Antibubble and Prediction of China's Stock Market and Real-Estate

Stock Market Prediction

Patterns, Trends and Predictions in Stock Market Indices and Fx Rates

An Overview of Stock Market Cycle

The Case for Gold

Astro-Cycles and Speculative Markets-Jensen

Astrology and Stock Market Forecasting McWhirter

The Real Estate Math Handbook

The Investor's Manifesto

Are you sure?

This action might not be possible to undo. Are you sure you want to continue?

CANCEL

OK

You've been reading!

NO, THANKS

OK

scribd

/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->