Considering the performance of Tesla and PG&E Corp over a 14-year period, how might the concept of skewness in returns provide insight into equity investment strategies? Positive skewness suggests a preference for investments with higher risk and potentially higher return, such as Tesla. Negative skewness suggests a preference for safer investments with lower return, such as PG&E Corp. Skewness does not apply to equity investments, only to bond investments.
The Correct Answer and Explanation is:
Correct Answer:
Positive skewness suggests a preference for investments with higher risk and potentially higher return, such as Tesla. Negative skewness suggests a preference for safer investments with lower return, such as PG&E Corp.
Explanation:
Skewness in returns refers to the asymmetry in the distribution of investment returns. A positively skewed return distribution means that while most returns are below the mean, there are occasional large positive returns that pull the average higher. Conversely, a negatively skewed distribution implies frequent small gains with the risk of rare but significant losses.
In the context of equity investments over a 14-year period, such as comparing Tesla and PG&E Corp, skewness can offer meaningful insights into investor behavior and risk tolerance. Tesla, known for its innovative disruption and high volatility, likely exhibits positive skewness in returns. Investors in Tesla may experience frequent periods of losses or modest gains, punctuated by substantial surges in value—such as those seen during major breakthroughs or market rallies. This positive skewness makes Tesla attractive to investors who are willing to take on greater short-term risk for the potential of outsized long-term gains.
On the other hand, PG&E Corp, a regulated utility company, typically offers more stable and predictable returns, which may be associated with negative skewness. This implies that returns are more clustered and consistent, with lower potential for extreme gains but also fewer chances of extreme losses—except in rare events such as lawsuits or natural disasters.
Understanding skewness helps investors align their portfolios with their risk preferences. Those seeking high-reward opportunities may favor stocks with positive skewness, while more risk-averse investors might prefer negatively skewed assets that prioritize capital preservation and income stability.
Contrary to the incorrect statement, skewness does apply to equity investments, not just bonds. It is a useful statistical measure for evaluating the return characteristics and risk profiles of a wide range of asset classes, including stocks.
