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Risk aversion and skewness preference

  • Post, Thierry
  • van Vliet, Pim
  • Levy, Haim

Empirically, co-skewness of asset returns seems to explain a substantial part of the cross-sectional variation of mean return not explained by beta. This finding is typically interpreted in terms of a risk averse representative investor with a cubic utility function. This paper questions this interpretation. We show that the empirical tests fail to impose risk aversion and the implied utility function takes an inverse S-shape. Unfortunately, the first-order conditions are not sufficient to guarantee that the market portfolio is the global maximum for this utility function, and our results suggest that the market portfolio is more likely to represent the global minimum. In addition, if we do impose risk aversion, then co-skewness has minimal explanatory power.

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Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 32 (2008)
Issue (Month): 7 (July)
Pages: 1178-1187

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Handle: RePEc:eee:jbfina:v:32:y:2008:i:7:p:1178-1187
Contact details of provider: Web page: http://www.elsevier.com/locate/jbf

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  1. Hansen, Lars Peter & Heaton, John & Yaron, Amir, 1996. "Finite-Sample Properties of Some Alternative GMM Estimators," Journal of Business & Economic Statistics, American Statistical Association, vol. 14(3), pages 262-80, July.
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  15. Levy, Haim, 1978. "Equilibrium in an Imperfect Market: A Constraint on the Number of Securities in the Portfolio," American Economic Review, American Economic Association, vol. 68(4), pages 643-58, September.
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