Daily Archives: May 14, 2021 at 06:42 pm EDT

Research Review | 14 May 2021 | Stock Returns

Long-Horizon Stock Returns Are Positively Skewed
Adam Farago and Erik Hjalmarsson (University of Gothenburg)
April 28, 2021
At long horizons, multiplicative compounding induces strong-to-extreme positive skewness into stock returns; the magnitude of the effect is primarily determined by single-period volatility. Consequently, at horizons greater than five years, returns –individual or portfolio– will be positively skewed under reasonable parametrizations. From an investor perspective, the strong positive skewness implies that the mean compound return will serve as a poor guide for typical long-horizon outcomes. Moreover, the large effects of compounding on higher-order moments are shown to affect the validity of Taylor expansions used to approximate preferences for skewness, when applied to returns of annual or longer horizons.

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