Skewness Preferences in Choice under Risk

93 Pages Posted: 26 Nov 2019

See all articles by Sebastian Ebert

Sebastian Ebert

Frankfurt School of Finance & Management gemeinnützige GmbH

Paul Karehnke

ESCP Europe - Department of Finance

Date Written: November 4, 2019

Abstract

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

Ebert, Sebastian and Karehnke, Paul, Skewness Preferences in Choice under Risk (November 4, 2019). Available at SSRN: https://ssrn.com/abstract=3480519 or http://dx.doi.org/10.2139/ssrn.3480519

Sebastian Ebert (Contact Author)

Frankfurt School of Finance & Management gemeinnützige GmbH ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

Paul Karehnke

ESCP Europe - Department of Finance ( email )

Paris Campus
79, Avenue de la Republique
Paris, 75011
France

HOME PAGE: http://sites.google.com/site/paulkarehnke/

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