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Why people choose negative expected return assets - an empirical examination of a utility theoretic explanation

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  • N. Bhattacharya
  • T. A. Garrett

Abstract

Using a theoretical extension of the Friedman and Savage (1948) utility function developed in Bhattacharyya (2003), we predict that for assets with negative expected returns, such as state lottery games, expected return will be a declining and convex function of skewness. That is, lottery players trade-off expected return for skewness. Using two samples of lottery game data, we find that our theoretical conclusions are supported by the empirical results. The findings obtained here not only contribute to the literature on why individuals may participate in unfair gambles, the framework could be extended to an analysis of the stock market where higher returns cannot be solely explained by risk (variance).

Suggested Citation

  • N. Bhattacharya & T. A. Garrett, 2008. "Why people choose negative expected return assets - an empirical examination of a utility theoretic explanation," Applied Economics, Taylor & Francis Journals, vol. 40(1), pages 27-34.
    • Handle: RePEc:taf:applec:v:40:y:2008:i:1:p:27-34
    DOI: 10.1080/00036840701335587
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    1. Eraker, Bjørn & Ready, Mark, 2015. "Do investors overpay for stocks with lottery-like payoffs? An examination of the returns of OTC stocks," Journal of Financial Economics, Elsevier, vol. 115(3), pages 486-504.
    2. Christian Gollier, 2020. "Aversion to risk of regret and preference for positively skewed risks," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 70(4), pages 913-941, November.
    3. Daniel Ladley & Guanqing Liu & James Rockey, 2016. "Margin Trading: Hedonic Returns and Real Losses," Discussion Papers in Economics 16/06, Division of Economics, School of Business, University of Leicester.
    4. Del Viva, Luca & Kasanen, Eero & Saunders, Anthony & Trigeorgis, Lenos, 2021. "US government TARP bailout and bank lottery behavior," Journal of Corporate Finance, Elsevier, vol. 66(C).
    5. Ladley, Daniel & Liu, Guanqing & Rockey, James, 2020. "Losing money on the margin," Journal of Economic Behavior & Organization, Elsevier, vol. 172(C), pages 107-136.
    6. Gollier, Christian, 2016. "Explaining rank-dependent utility with regret and rejoicing," IDEI Working Papers 863, Institut d'Économie Industrielle (IDEI), Toulouse.
    7. Narayan, Paresh Kumar & Ahmed, Huson Ali, 2014. "Importance of skewness in decision making: Evidence from the Indian stock exchange," Global Finance Journal, Elsevier, vol. 25(3), pages 260-269.
    8. Griffith, Andrew P. & Lewis, Karen E. & Boyer, Christopher N., 2015. "Timing the Purchase of Livestock Risk Protection Insurance for Feeder Cattle," 2015 Annual Meeting, January 31-February 3, 2015, Atlanta, Georgia 196869, Southern Agricultural Economics Association.
    9. Eichner, Thomas & Wagener, Andreas, 2011. "Increases in skewness and three-moment preferences," Mathematical Social Sciences, Elsevier, vol. 61(2), pages 109-113, March.

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