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Why people choose negative expected return assets - an empirical examination of a utility theoretic explanation

  • N. Bhattacharya
  • T. A. Garrett

Using a theoretical extension of the Friedman and Savage (1948) utility function developed in Bhattacharyya (2003), we predict that for assets with negative expected returns, such as state lottery games, expected return will be a declining and convex function of skewness. That is, lottery players trade-off expected return for skewness. Using two samples of lottery game data, we find that our theoretical conclusions are supported by the empirical results. The findings obtained here not only contribute to the literature on why individuals may participate in unfair gambles, the framework could be extended to an analysis of the stock market where higher returns cannot be solely explained by risk (variance).

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Article provided by Taylor & Francis Journals in its journal Applied Economics.

Volume (Year): 40 (2008)
Issue (Month): 1 ()
Pages: 27-34

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Handle: RePEc:taf:applec:v:40:y:2008:i:1:p:27-34
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  1. Garrett, Thomas A. & Sobel, Russell S., 1999. "Gamblers favor skewness, not risk: Further evidence from United States' lottery games," Economics Letters, Elsevier, vol. 63(1), pages 85-90, April.
  2. Ali, Mukhtar M, 1977. "Probability and Utility Estimates for Racetrack Bettors," Journal of Political Economy, University of Chicago Press, vol. 85(4), pages 803-15, August.
  3. Lisa Farrell & Roger Hartley, 2002. "Can expected utility theory explain gambling?," Open Access publications 10197/539, School of Economics, University College Dublin.
  4. Lisa Farrell & Roger Hartley, . "Can Expected Utility Theory Explain Gambling?," Discussion Papers in Public Sector Economics 00/8, Department of Economics, University of Leicester.
  5. Quiggin, John, 1991. "On the Optimal Design of Lotteries," Economica, London School of Economics and Political Science, vol. 58(229), pages 1-16, February.
  6. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
  7. McEnally, Richard W, 1974. "A Note on the Return Behavior of High Risk Common Stocks," Journal of Finance, American Finance Association, vol. 29(1), pages 199-202, March.
  8. Melissa Schettini Kearney, 2002. "State Lotteries and Consumer Behavior," NBER Working Papers 9330, National Bureau of Economic Research, Inc.
  9. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279.
  10. Kraus, Alan & Litzenberger, Robert H, 1976. "Skewness Preference and the Valuation of Risk Assets," Journal of Finance, American Finance Association, vol. 31(4), pages 1085-1100, September.
  11. Bailey, Martin J & Olson, Mancur & Wonnacott, Paul, 1980. "The Marginal Utility of Income Does not Increase: Borrowing, Lending, and Friedman-Savage Gambles," American Economic Review, American Economic Association, vol. 70(3), pages 372-79, June.
  12. Donkers, Bas & Melenberg, Bertrand & Van Soest, Arthur, 2001. " Estimating Risk Attitudes Using Lotteries: A Large Sample Approach," Journal of Risk and Uncertainty, Springer, vol. 22(2), pages 165-95, March.
  13. Joseph Golec & Maurry Tamarkin, 1998. "Bettors Love Skewness, Not Risk, at the Horse Track," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 205-225, February.
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