Get access

Price Convexity and Skewness



    Search for more papers by this author
    • Jianguo Xu is at the Desautels Faculty of Management, McGill University, Montreal, Canada. The author is especially grateful to an anonymous referee for insightful and constructive feedback. The author thanks Simon Gervais, Daniel Graham, John Graham, Hong Han, Pete Kyle, Robert F. Stambaugh (the editor), Curtis Taylor, S. Viswanathan, Ho-Mou Wu, Liu Zheng, an anonymous associate editor, and seminar participants at Duke University for comments and suggestions. Remaining errors and inaccuracies are my own.


This paper develops a model in which investors who are prohibited from short selling agree to disagree on the precision of a publicly observed signal. The model implies that the equilibrium price is a convex function of the public signal. The model predicts that (1) the stock price reacts more to good news than to bad news; (2) the skewness of stock returns is positively correlated with contemporaneous returns, but negatively correlated with lagged returns; (3) short sale constraints increase rather than decrease skewness; and (4) disagreement about information precision increases skewness. Empirical tests conducted find supportive evidence for all these predictions.