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Skewness preference, mean–variance and the demand for put options
Author(s) -
Poitras Geoffrey,
Heaney John
Publication year - 1999
Publication title -
managerial and decision economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.288
H-Index - 51
eISSN - 1099-1468
pISSN - 0143-6570
DOI - 10.1002/(sici)1099-1468(199909)20:6<327::aid-mde948>3.0.co;2-0
Subject(s) - skewness , variance (accounting) , preference , economics , econometrics , asset (computer security) , standard deviation , statistics , mathematics , computer science , microeconomics , computer security , accounting
This paper compares the mean–variance and the mean–variance–skewness approaches to modelling expected utility. Attention is focused on a problem encountered in risk management: determining the optimal demand for a put option hedging the return on an asset with a negatively skewed return distribution. It is demonstrated theoretically that incorporating positive skewness preference into the decision‐maker's objective function typically produces a reduction in the demand for put options when compared with the mean–variance solution. A state‐dependent example is provided to illustrate how a mean–variance–skewness objective can result in a significant reduction in the optimal amount of crop insurance demanded when compared with the mean–variance solution. Copyright © 1999 John Wiley & Sons, Ltd.