Question

In 200 words or less, explain the relationship between skewness of a return distribution and investors’ utility preferences.

Answer 1

A skewed return distribution implies that the asset class can generate more extreme returns in positive or negative side. For a conservative investor, such high skewness or long tails could be source of additional volatility and risk. A prudent investor would prefer an asset class with a return distribution with a high mean and low variance. Since a large skew can impact the variance adversely with the underlying distribution's variance getting increased. Thus, in this manner, the skewness affect investors preference and a investor would prefer an asset with lower skew and variance.