Stochastic Dominance and Behavior towards Risk: The Market for iShares

Abstract:     
Prospect theory suggests that risk seeking can occur when investors face losses and thus an S-shaped utility function can be useful in explaining investor behavior. Using stochastic dominance procedures, Post and Levy (2005) find evidence of reverse S-shaped utility functions. This is consistent with investors exhibiting risk-seeking tendencies in bull markets and risk aversion in bear markets. We use both ascending and descending stochastic dominance procedures to test for risk averse and risk seeking behavior. By partitioning iShares’ return distributions into negative and positive return regions, we find evidence of all four utility functions: concave, convex, S-shaped and reverse S-shaped.

Number of Pages in PDF File: 26

Keywords: stochastic dominance; risk aversion, risk seeking

JEL Classification: G11, G15

working papers series