The skewness index: uncovering the relationship with volatility and market returns

The SKEW index of the Chicago Board Options Exchange (CBOE), launched in February 2011, measures the tail risk not fully captured by the VIX index. In this paper we introduce, for the first time, a skewness index for the Italian stock market (ITSKEW) and investigate the pairwise and trilateral relations of this index with volatility and market returns. The results are compared with those of the US market. Data for the period 3 January 2011 to 29 December 2017 are used and three main results are found. First, in both the US and the Italian markets, the skewness index acts as a measure of market greed, as opposed to market fear, in the sense that it captures investor excitement to a larger extent than investor fear. Second, increases in the skewness index are related to returns with high significance in the Granger causality test, while the reverse is not the case. Last, volatility and skewness may give conflicting signals. When skewness and volatility indices move in the same direction, investors should rely on volatility because it has a stronger influence on market returns. The implications for investors and policy-makers are outlined.

Automated summary

This paper introduces a skewness index for the Italian stock market and explores its relations with volatility and market returns, finding that the skewness index reflects market greed more than fear. Increases in the skewness index are significantly related to market returns, with conflicting signals between volatility and skewness. Investors are advised to rely on volatility rather than skewness when the two indices move in the same direction.