Beta and Coskewness Pricing: Perspective from Probability Weighting

58 Pages Posted: 12 May 2020 Last revised: 3 Jun 2020

See all articles by Yun Shi

Yun Shi

East China Normal University - Academy of Statistics and Interdisciplinary Sciences, Faculty of Economics and Management

Xiangyu Cui

Shanghai University of Finance and Economics - School of Statistics and Management

Xun Yu Zhou

Columbia University - Department of Industrial Engineering and Operations Research (IEOR)

Date Written: February 19, 2020

Abstract

The security market line is often flat or downward-sloping. We hypothesize that probability weighting plays a role and that one ought to differentiate between periods in which agents overweight extreme events and those in which they underweight them. Overweighting inflates the probability of extremely bad events and demands greater compensation for beta risk. Underweighting has the opposite effect. Overall, these two effects offset each other, resulting in a flat or slightly negative return--beta relationship. Similarly, overweighting the tails enhances the negative relationship between return and coskewness, whereas underweighting reduces it. We support our theory through an extensive empirical study.

Keywords: Probability weighting, Beta, Coskewness, Asset Pricing

JEL Classification: G4, G12

Suggested Citation

Shi, Yun and Cui, Xiangyu and Zhou, Xunyu, Beta and Coskewness Pricing: Perspective from Probability Weighting (February 19, 2020). Available at SSRN: https://ssrn.com/abstract=3579960 or http://dx.doi.org/10.2139/ssrn.3579960

Yun Shi (Contact Author)

East China Normal University - Academy of Statistics and Interdisciplinary Sciences, Faculty of Economics and Management ( email )

North Zhongshan Road Campus
3663 N. Zhongshan Rd.
Shanghai, 200062
China

Xiangyu Cui

Shanghai University of Finance and Economics - School of Statistics and Management ( email )

777 Guoding Road
Shanghai, Shanghai 200433
China

Xunyu Zhou

Columbia University - Department of Industrial Engineering and Operations Research (IEOR) ( email )

331 S.W. Mudd Building
500 West 120th Street
New York, NY 10027
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
55
Abstract Views
355
rank
445,096
PlumX Metrics