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

25 May 2005

journal article
research article
Published by Oxford University Press (OUP) in The Review of Financial Studies

Vol. 18 (3) , 925-953
https://doi.org/10.1093/rfs/hhi021

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

This publication has 34 references indexed in Scilit:

Nonlinear Pricing Kernels, Kurtosis Preference, and Evidence from the Cross Section of Equity Returns
The Journal of Finance, 2002
Mental Accounting, Loss Aversion, and Individual Stock Returns
The Journal of Finance, 2001
Prospect Theory and Asset Prices
The Quarterly Journal of Economics, 2001
Necessary Conditions for the CAPM
Journal of Economic Theory, 1997
Myopic Loss Aversion and the Equity Premium Puzzle
The Quarterly Journal of Economics, 1995
Common risk factors in the returns on stocks and bonds
Journal of Financial Economics, 1993
The Cross-Section of Expected Stock Returns
The Journal of Finance, 1992
A Leisurely Look at the Bootstrap, the Jackknife, and Cross-Validation
The American Statistician, 1983
Portfolio Efficient Sets
Econometrica, 1982
Bootstrap Methods: Another Look at the Jackknife
The Annals of Statistics, 1979