Risk Aversion and Skewness Preference: A Comment
19 Pages Posted: 23 Feb 2006
Date Written: 29 2003 4,
Empirically, co-skewness of asset returns seems to explain a substantial part of the cross-sectional variation of mean return not explained by beta. Thisfinding is typically interpreted in terms of a risk averse representativeinvestor with a cubic utility function. This comment questions thisinterpretation. We show that the empirical tests fail to impose risk aversionand the implied utility function takes an inverse S-shape. Unfortunately, thefirst-order conditions are not sufficient to guarantee that the market portfoliois the global maximum for an inverse S-shaped utility function, and ourresults suggest that the market portfolio is more likely to represent theglobal minimum than the global maximum. In addition, if we impose riskaversion, then co-skewness has minimal explanatory power.
Keywords: asset pricing, risk aversion, skewness preference, representative investor, three-moment model
JEL Classification: M, M41, G3, C19
Suggested Citation: Suggested Citation