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Risk Aversion and Skewness Preference: a comment

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  • Post, G.T.
  • van Vliet, P.

Abstract

Empirically, 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.

Suggested Citation

  • Post, G.T. & van Vliet, P., 2003. "Risk Aversion and Skewness Preference: a comment," ERIM Report Series Research in Management ERS-2003-009-F&A, 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.
    • Handle: RePEc:ems:eureri:319
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    References listed on IDEAS

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    1. Thierry Post, 2003. "Empirical Tests for Stochastic Dominance Efficiency," Journal of Finance, American Finance Association, vol. 58(5), pages 1905-1932, October.
    2. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
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    4. Thierry Post, 2003. "Empirical Tests for Stochastic Dominance Efficiency," Journal of Finance, American Finance Association, vol. 58(5), pages 1905-1931, October.
    5. Levy, Haim, 1969. "A Utility Function Depending on the First Three Moments: Comment," Journal of Finance, American Finance Association, vol. 24(4), pages 715-719, September.
    6. Tsiang, S C, 1972. "The Rationale of the Mean-Standard Deviation Analysis, Skewness Preference, and the Demand for Money," American Economic Review, American Economic Association, vol. 62(3), pages 354-371, June.
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    8. Simkowitz, Michael A. & Beedles, William L., 1978. "Diversification in a Three-Moment World," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(5), pages 927-941, December.
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    12. 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 643-658, September.
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    Cited by:

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    3. Belghitar, Yacine & Clark, Ephraim & Kassimatis, Konstantino, 2011. "The prudential effect of strategic institutional ownership on stock performance," International Review of Financial Analysis, Elsevier, vol. 20(4), pages 191-199, August.

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    More about this item

    Keywords

    asset pricing; representative investor; risk aversion; skewness preference; three-moment model;
    All these keywords.

    JEL classification:

    • C19 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Other
    • G3 - Financial Economics - - Corporate Finance and Governance
    • M - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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