Risk Aversion and Skewness Preference: a comment
AbstractEmpirically, co-skewness of asset returns seems to explain a substantial part of the cross-sectional variation of mean return not explained by beta. Thisfinding is typically interpreted in terms of a risk averse representativeinvestor with a cubic utility function. This comment questions thisinterpretation. We show that the empirical tests fail to impose risk aversionand the implied utility function takes an inverse S-shape. Unfortunately, thefirst-order conditions are not sufficient to guarantee that the market portfoliois the global maximum for an inverse S-shaped utility function, and ourresults suggest that the market portfolio is more likely to represent theglobal minimum than the global maximum. In addition, if we impose riskaversion, then co-skewness has minimal explanatory power.
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Bibliographic InfoPaper provided by Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam. in its series Research Paper with number ERS-2003-009-F&A.
Date of creation: 29 Apr 2003
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asset pricing; risk aversion; representative investor; skewness preference; three-moment model;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-12-07 (All new papers)
- NEP-FIN-2003-12-07 (Finance)
- NEP-RMG-2003-12-07 (Risk Management)
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