Skewness Preference and Risk Seeking Behavior

What is it about?

Whenever negative outcomes are as likely as positive outcomes, in finance parlance we say outcomes are normally distributed. If we find, however, that extreme positive outcomes are more likely in relation to extreme negative outcomes, we say outcomes are positively skewed or exhibit positive skewness. Historically, a preference for positive skewness has been interpreted as a characteristic of risk averse agents. The most popular outcomes we study in financial economics are returns on investments. In this study, using data on projects that transition from private to public equity markets, we demonstrate that preference for positive skewness is more likely to be associated with investors who like to take risk (risk seeking agents) in relation to investors who prefer relatively safe investments (risk averse agents).

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Why is it important?

If investors' preferences are not well understood, we are unable to construct appropriate measures of risk within financial markets. This is the case because a measure of risk that is appropriate to risk averse agents may not be appropriate to risk seeking agents. For instance, while an increase in the volatility of an outcome, be it stock returns, exchange rates, inflation etc. implies an increase in risk if investors are risk averse, this is not necessarily the case in the presence of risk seeking agents.

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