Date of Award

5-2012

Degree Type

Report

Degree Name

Master of Science (MS)

Department

Economics and Finance

First Advisor

Dr. Randy Simmons

Abstract

In this study, I show an effect of the statistical fourth moment on stock returns. In the mean-variance framework, rational investors follow two strategies: optimize the mean{variance of return and diversify the portfolio. Regarding the first approach, investors intend to generate the maximum level of return while facing a constant level of risk (or, the standard deviation) of return. It is possible that firm specific risk can be concentrated in the portfolio. However, diversification of the assets can eliminate that (idiosyncratic) risk from the portfolio. After a long period of time, in a diversified portfolio the shape of the return distribution appears to be peaked around the average value of the return compared with that of the typical shape of the return distribution. If investors have a preference for skewness in their returns, they also can produce peakedness in the shape of the distribution. The statistical fourth moment (kurtosis) measures the magnitude of peakedness of the distribution. As the kurtosis of the distribution in- creases the distribution will appear more peaked. I find evidence that kurtosis positively and significantly predicts future stock returns over the period 1981-2011. The effect remains after controlling for other factors in multivariate regressions.

Comments

This work made publicly available electronically on September 4, 2012.

9-4-2012