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Does Risk Seeking drive Asset Prices?

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Author Info
Thierry Post () (Erasmus University Rotterdam)
Haim Levy (The Hebrew University of Jerusalem)

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Abstract

We investigate whether risk seeking or non-concave utility functions can help to explain the cross-sectional pattern0 of stock returns. For this purpose, we analyze the stochastic dominance efficiency classification of the value-weighted market portfolio relative to benchmark portfolios based on market capitalization, book-to-market equity ratio and momentum. We use various existing and novel stochastic dominance criteria that account for the possibility that investors exhibit local risk seeking behavior. Our results suggest that Markowitz type utility functions, with risk aversion for losses and risk seeking for gains, can capture the cross-sectional pattern of stock returns. The low average yield on big caps, growth stocks and past losers may reflect investors' twin desire for downside protection in bear markets and upside potential in bull markets.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 02-070/2.

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Date of creation: 10 Jul 2002
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Handle: RePEc:dgr:uvatin:20020070

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  7. Berk, Jonathan B., 1997. "Necessary Conditions for the CAPM," Journal of Economic Theory, Elsevier, vol. 73(1), pages 245-257, March. [Downloadable!] (restricted)
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  17. Wang, Zhenyu, 1998. "Efficiency loss and constraints on portfolio holdings1," Journal of Financial Economics, Elsevier, vol. 48(3), pages 359-375, June. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Wing-Keung Wong & Raymond H. Chan, 2005. "Prospect and Markowitz Stochastic Dominance," Departmental Working Papers wp0505, National University of Singapore, Department of Economics. [Downloadable!]
  2. Olivier Scaillet & Nikolas Topaloglou, 2005. "Testing for Stochastic Dominance Efficiency," FAME Research Paper Series rp154, International Center for Financial Asset Management and Engineering. [Downloadable!]
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