Essays on the skewness of firm fundamentals and stock returns

Abstract

This dissertation investigates whether the skewness of firm fundamentals is related to future firm performance and stock returns. Essay one discusses the recent research on the relation between higher-order moments of fundamentals and stock returns. Essay two discusses fundamental skewness and cross-sectional stock returns. I present two distinct theoretical models of firm fundamentals with nonzero skewness. Both models imply a positive relation between the skewness of firm fundamentals and expected stock return. Consistent with the implication, I show that the skewness measures of firm fundamentals positively predicts cross-sectional stock returns. I further find evidence supporting both models. That is, higher fundamental skewness implies not only higher future firm growth option but also higher future firm profitability. The results cannot be explained by existing risk factors and return predictors including the skewness of stock returns. The third essay documents that the conditional skewness of aggregate corporate earnings negatively predicts the stock market returns for horizons beyond six months and up to eight years. The evidence is robust to controlling for existing predictors such as the book-to-market ratio, interest term spread, credit spread, and cay. I present a theoretical model that is consistent with the empirical evidence. The interaction of the two key ingredients of the model, path dependence and non-Gaussian innovations in the aggregate corporate earnings process, implies the negative impact of productivity-enhancing technology spillover on the stock market returns.