Equilibrium Underdiversification and the Preference for Skewness

Posted: 25 Jun 2008

See all articles by Todd Mitton

Todd Mitton

Brigham Young University - J. Willard and Alice S. Marriott School of Management

Keith Vorkink

Brigham Young University - J. Willard and Alice S. Marriott School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: 2007

Abstract

We develop a one-period model of investor asset holdings where investors have heterogeneous preference for skewness. Introducing heterogeneous preference for skewness allows the model's investors, in equilibrium, to underdiversify. We find support for our model's three key implications using a dataset of 60,000 individual investor accounts. First, we document that the portfolio returns of underdiversified investors are substantially more positively skewed than those of diversified investors. Second, we show that the apparent mean-variance inefficiency of underdiversified investors can be largely explained by the fact that investors sacrifice mean-variance efficiency for higher skewness exposure. Furthermore, we show that idiosyncratic skewness, and not just coskewness, can impact equilibrium prices. Third, the underdiversification of investors does not appear to be coincidentally related to skewness. Stocks most often selected by underdiversified investors have substantially higher average skewness—especially idiosyncratic skewness—than stocks most often selected by diversified investors.

Keywords: G11, G12

Suggested Citation

Mitton, Todd and Vorkink, Keith, Equilibrium Underdiversification and the Preference for Skewness (2007). The Review of Financial Studies, Vol. 20, Issue 4, pp. 1255-1288, 2007. Available at SSRN: https://ssrn.com/abstract=1151161 or http://dx.doi.org/10.1093/rfs/hhm011

Todd Mitton (Contact Author)

Brigham Young University - J. Willard and Alice S. Marriott School of Management ( email )

Provo, UT 84602
United States
801-422-1763 (Phone)

Keith Vorkink

Brigham Young University - J. Willard and Alice S. Marriott School of Management ( email )

Provo, UT 84602
United States

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