Does Risk Seeking Drive Stock Prices? A Stochastic Dominance Analysis of Aggregate Investor Preferences and Beliefs

Posted: 29 Feb 2008

See all articles by Thierry Post

Thierry Post

Graduate School of Business of Nazarbayev University

Date Written: 2005

Abstract

We use various stochastic dominance criteria that account for (local) risk seeking to analyze market portfolio efficiency relative to benchmark portfolios formed on market capitalization, book-to-market equity ratio and price momentum. Our results suggest that reverse S-shaped utility functions with risk aversion for losses and risk seeking for gains can explain stock returns. The results are also consistent with a reverse S-shaped pattern of subjective probability transformation. The low average yield on big caps, growth stocks, and past losers may reflect investors` twin desire for downside protection in bear markets and upside potential in bull markets.

Keywords: time optimal control problems, Neumann parabolic equations with an infinite number of variables, Dubovitskii-Milyutin theorem, conical approximations, optimality conditions, Weierstrass theorem

Suggested Citation

Post, Thierry, Does Risk Seeking Drive Stock Prices? A Stochastic Dominance Analysis of Aggregate Investor Preferences and Beliefs ( 2005). The Review of Financial Studies, Vol. 18, Issue 3, pp. 925-953, 2005, Available at SSRN: https://ssrn.com/abstract=900691

Thierry Post (Contact Author)

Graduate School of Business of Nazarbayev University ( email )

53 Kabanbay Batyra Avenue
Astana, 010000
Kazakhstan

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