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Skewness Preference, Risk Aversion, and the Precedence Relations on Stochastic Changes

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  • W. Henry Chiu

    () (School of Economic Studies, The University of Manchester, Manchester, M13 9PL, United Kingdom)

Abstract

This paper provides a general choice-theoretic characterization of the trade-off between risk and skewness, whose importance in understanding risk-taking behavior is well documented in empirical studies. The condition under which the prudence measure (Kimball 1990) characterizes the strength of an individual's downside-risk aversion against his own risk aversion is identified and interpreted in a unifying framework based on the concept of one stochastic dominant change preceding another and that of the desirability of a stochastic change. The framework is also shown to be useful for a better understanding of the Arrow-Pratt measure, the stronger Ross measure, and the coincidence of the characterizations of downside-risk aversion and prudence, as well as the relationship between stochastic dominances of different degrees.

Suggested Citation

  • W. Henry Chiu, 2005. "Skewness Preference, Risk Aversion, and the Precedence Relations on Stochastic Changes," Management Science, INFORMS, vol. 51(12), pages 1816-1828, December.
  • Handle: RePEc:inm:ormnsc:v:51:y:2005:i:12:p:1816-1828
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    File URL: http://dx.doi.org/10.1287/mnsc.1050.0431
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    References listed on IDEAS

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