The pricing of skewness: Evidence from the Johannesburg Stock Exchange

ABSTRACT The historical skewness of stock return distributions could potentially affect future stock returns. Previous studies in developed markets have shown that investors prefer shares exhibiting positively skewed or ‘lottery-like’ payoff profiles. The higher demand for these shares results in a negative relationship between skewness and expected stock returns. This study investigates the extent to which asymmetrical returns are priced on the Johannesburg Stock Exchange over the period August 2002 to December 2019. Using portfolio-level analysis, this study analyses the returns of quintile portfolios sorted on past self-skewness. Risk-adjusted returns are evaluated against an equally weighted benchmark. In addition, the presence of a monotonic relationship between past self-skewness and future returns is tested with the monotonic relation test of Patton and Timmermann (2010), as well as the Wolak (1987, 1989) test. Unlike the developed market evidence, this study finds evidence of a positive relationship between past self-skewness and future returns on the JSE. This effect remains even after controlling for size and industry effects. The results suggest that positive skewness is rewarded on a risk-adjusted basis. Overall, the study provides insights for investors regarding the importance of considering the past asymmetry of stock return distributions in investment decision-making processes.