Rolling the Skewed Die: Economic Foundations of the Demand for Skewness
64 Pages Posted: 10 May 2018
Date Written: April 23, 2018
Skewness is pervasive across financial instruments, and the literature has documented that many investors seek idiosyncratic skewness in their portfolios. In response, there are some theoretical models that study implications of the preference for skewness, but using utility functions where the preference for right skewness is hard-wired. Drawing from status concerns, we derive a utility function reminiscent of Friedman and Savage (1948) that leads the investor to demand skewness --right or left skewness. We then consider a parsimonious set of securities that allow the investor to select the exact optimal level of right or left skewness. Our analysis yields a rich set of results broadly consistent with empirical observations.
Keywords: endogenous demand for skewness, utility function, aspiration, status
JEL Classification: G02, G11
Suggested Citation: Suggested Citation