Abstract - Conditional Skewness of Stock Market Returns in Developed and Emerging Markets and its Economic Fundamentals

We use a quantile-based measure of conditional skewness or asymmetry of asset returns that is robust to outliers and therefore particularly suited for recalcitrant series such as emerging market returns. We study the following portfolio returns: developed markets, emerging markets, the world, and separately 73 countries. We find that the conditional asymmetry of returns varies significantly over time. This is true even after taking into account conditional volatility effects (GARCH) and unconditional skewness effects (TARCH) in returns. Interestingly, we find that the conditional asymmetry in developing countries features low correlation with that in emerging markets. This finding has implications for portfolio allocation, given the fact that the correlation of the returns themselves has been historically high and is increasing. In contrast to conditional volatility fluctuations, which are hard to explain with macroeconomic fundamentals, we find a strong relationship between the conditional skewness and macroeconomic variables. Moreover, the low correlation between conditional asymmetry across developed and emerging markets can be explained by macroeconomic fundamental factors in the cross-section, as both markets feature opposite responses to those fundamentals. The economic significance of the conditional asymmetry is also demonstrated in an international portfolio allocation setting.

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