Volatility Shocks, Leverage Effects, and Time-Varying Conditional Skewness

I use GARCH-X specifications for stock index returns to investigate the connections between conditional skewness and variance shocks computed from realized variances. The evidence indicates that the conditional skewness of index returns is strongly influenced by variance shocks and displays a remarkable degree of persistence. Indeed, variance shocks not only drive changes in conditional skewness, but also act as a common factor that generates substantial negative correlation between contemporaneous changes in the conditional volatility and conditional skewness of index returns. The resultant linkages between these conditional moments could have important implications in asset pricing, portfolio selection, and risk management applications.