Risk aversion and skewness preference

Thierry Post; Pim van Vliet; Haim Levy

doi:10.1016/j.jbankfin.2006.02.008

Risk aversion and skewness preference

Thierry Post
, Pim van Vliet
, Haim Levy

Erasmus University Rotterdam

Research output: Contribution to journal › Article › peer-review

78 Citations (Scopus)

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. 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.

Original language	English
Pages (from-to)	1178-1187
Number of pages	10
Journal	Journal of Banking and Finance
Volume	32
Issue number	7
DOIs	https://doi.org/10.1016/j.jbankfin.2006.02.008
Publication status	Published - Jul 2008
Externally published	Yes

Funding

We thank Marien de Gelder for programming assistance. We appreciate the comments by two anonymous referees, Winfried Hallerbach, Jan van der Meulen, Nico van der Sar and Jaap Spronk, as well as participants at the 30th and 32th meeting of the EURO Working Group on Financial Modeling, FMA European conference 2003 Dublin, and seminars at Catholic University of Leuven, Erasmus University Rotterdam, Ghent University and Maastricht University. Financial support by Tinbergen Institute, Erasmus Research Institute of Management and Erasmus Center of Financial Research is gratefully acknowledged. Any remaining errors are our own.

Keywords

3M CAPM
Asset pricing
Asymmetry
Co-skewness

ASJC Scopus subject areas

Finance
Economics and Econometrics

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10.1016/j.jbankfin.2006.02.008

Cite this

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title = "Risk aversion and skewness preference",

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. 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.",

keywords = "3M CAPM, Asset pricing, Asymmetry, Co-skewness",

author = "Thierry Post and \{van Vliet\}, Pim and Haim Levy",

note = "Funding Information: We thank Marien de Gelder for programming assistance. We appreciate the comments by two anonymous referees, Winfried Hallerbach, Jan van der Meulen, Nico van der Sar and Jaap Spronk, as well as participants at the 30th and 32th meeting of the EURO Working Group on Financial Modeling, FMA European conference 2003 Dublin, and seminars at Catholic University of Leuven, Erasmus University Rotterdam, Ghent University and Maastricht University. Financial support by Tinbergen Institute, Erasmus Research Institute of Management and Erasmus Center of Financial Research is gratefully acknowledged. Any remaining errors are our own. ",

year = "2008",

month = jul,

doi = "10.1016/j.jbankfin.2006.02.008",

language = "English",

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AU - Post, Thierry

AU - van Vliet, Pim

AU - Levy, Haim

N1 - Funding Information: We thank Marien de Gelder for programming assistance. We appreciate the comments by two anonymous referees, Winfried Hallerbach, Jan van der Meulen, Nico van der Sar and Jaap Spronk, as well as participants at the 30th and 32th meeting of the EURO Working Group on Financial Modeling, FMA European conference 2003 Dublin, and seminars at Catholic University of Leuven, Erasmus University Rotterdam, Ghent University and Maastricht University. Financial support by Tinbergen Institute, Erasmus Research Institute of Management and Erasmus Center of Financial Research is gratefully acknowledged. Any remaining errors are our own.

PY - 2008/7

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N2 - 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.

AB - 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.

KW - 3M CAPM

KW - Asset pricing

KW - Asymmetry

KW - Co-skewness

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Risk aversion and skewness preference

Abstract

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Keywords

ASJC Scopus subject areas

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