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Skewness preference, mean-variance and the demand for put options

Author

Listed:
  • Geoffrey Poitras

    (Faculty of Business Administration, Simon Fraser University, Burnaby, B.C., Canada)

  • John Heaney

    (Faculty of Business Administration, Simon Fraser University, Burnaby, B.C., Canada)

Abstract

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.

Suggested Citation

  • Geoffrey Poitras & John Heaney, 1999. "Skewness preference, mean-variance and the demand for put options," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 20(6), pages 327-342.
    • Handle: RePEc:wly:mgtdec:v:20:y:1999:i:6:p:327-342
    DOI: 10.1002/(SICI)1099-1468(199909)20:6<327::AID-MDE948>3.0.CO;2-0
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    References listed on IDEAS

    as
    1. Loistl, Otto, 1976. "The Erroneous Approximation of Expected Utility by Means of a Taylor's Series Expansion: Analytic and Computational Results," American Economic Review, American Economic Association, vol. 66(5), pages 904-910, December.
    2. Hassett, Matt & Stephen Sears, R. & Trennepohl, Gary L., 1985. "Asset preference, skewness, and the measurement of expected utility," Journal of Economics and Business, Elsevier, vol. 37(1), pages 35-47, February.
    3. Ormiston, Michael B & Quiggin, John, 1993. "Two-Parameter Decision Models and Rank-Dependent Expected Utility," Journal of Risk and Uncertainty, Springer, vol. 7(3), pages 273-282, December.
    4. Kroll, Yoram & Levy, Haim & Markowitz, Harry M, 1984. "Mean-Variance versus Direct Utility Maximization," Journal of Finance, American Finance Association, vol. 39(1), pages 47-61, March.
    5. Levy, H & Markowtiz, H M, 1979. "Approximating Expected Utility by a Function of Mean and Variance," American Economic Review, American Economic Association, vol. 69(3), pages 308-317, June.
    6. David E. Bell, 1995. "Risk, Return, and Utility," Management Science, INFORMS, vol. 41(1), pages 23-30, January.
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    2. Ali, Heba, 2019. "Does downside risk matter more in asset pricing? Evidence from China," Emerging Markets Review, Elsevier, vol. 39(C), pages 154-174.

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