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

Geoffrey Poitras and John Heaney
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John Heaney: Faculty of Business Administration, Simon Fraser University, Burnaby, B.C., Canada, Postal: Faculty of Business Administration, Simon Fraser University, Burnaby, B.C., Canada

Managerial and Decision Economics, 1999, vol. 20, issue 6, 327-342

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.

Date: 1999
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Persistent link: https://EconPapers.repec.org/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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