Skewness Preferences in Choice under Risk
93 Pages Posted: 26 Nov 2019
Date Written: November 4, 2019
Skewness preferences — preferences toward low-probability, high-impact risks — were identified as crucial determinants of economic behavior. This paper provides a unified analysis of skewness preferences within leading theories of choice under risk. We show that most theories imply skewness-seeking (i.e., more positive skewness is better), which is consistent with empirical evidence. We further propose a definition of the importance of skewness — the order of skewness preference — for a given theory. We find that skewness is of third-order importance within the expected utility (EU) model with commonly used utility functions, but of first-order importance within most behavioral (non-EU) models. Even when allowing for arbitrary increasing utility functions, we prove that EU cannot induce first-order skewness-seeking. This impossibility result shows that one must depart from the EU paradigm if one believes that skewness is of first-order importance in choice under risk.
Keywords: risk preferences, downside risk aversion, prudence, skewness preferences, orders of skewness preferences
JEL Classification: D81, D91
Suggested Citation: Suggested Citation