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RFS Advance Access published online on May 25, 2005
Review of Financial Studies, doi:10.1093/rfs/hhi021
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© The Author 2005. Published by Oxford University Press. All rights reserved. For Permissions, please email: journals.permissions@oupjournals.org

Article

Does Risk Seeking Drive Stock Prices?

Thierry Post 1 and Haim Levy 2
1 Erasmus University Rotterdam, P.O. Box 1738, 3000 DR, Rotterdam, The Netherlands
2 School of Business of The Hebrew University of Jerusalem, Israel


  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.


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