Revealed Preferences for Portfolio Selection - Does Skewness Matter?

Abstract

In this study, we consider two competing methods, traditional mean/variance efficient portfolio and a generalization allowing for skewness as a Bayesian decision problem. Using observed (market) weights we investigate the market’s preference for risk. We do this with bilevel optimization, where the first level maximizes the investor’s objective (utility) function and the second level minimizes the discrepancy between the market and the optimal portfolio weights. This reveals the market’s preference for risk by estimating the implied market utility. Numerical results show that the market’s preferences are better explained when skewness is included.

Keywords: Market preferences, Mean-Variance-Skewness optimal portfolios, Bi-level optimization

JEL Classification: C11, C61, G11