Skewness, Hope and Bubbles

As economists Joseph Golec and Maurry Tamarkin have shown in [1], studies of horse race betting have empirically established a long shot anomaly; that is, low-probabiliy, high-variance bets (long shots) provide low mean returns and high-probability, low variance bets provide relatively high mean returns. Because bettors willingly accept low-return, high-variance bets, researchers conclude that bettors are risk lovers. In their study, Golec and Tamarkin show that the data are at least as consistent with risk aversion as they are with risk loving when one explicitly considers the skewness of bet returns. Because the variance and skewness of bet returns are highly correlated, bettors may appear to prefer variance when it is skewness that they crave.

For the same reason some investors may be easily over-attracted by new financial products (CDOs, commodities) or new industrial sectors: the Dot-Com sector between 1995 and 2001. This new investment support may have no track record, even negative expected return but they carry hope for change and hence a positive skewness!!

To answer the difficult question "what will be the next financial bubble?", one might ask first where investors hope seem to focus today ? Renewable energy?

[1] Joseph Golec & Maurry Tamarkin, 1998. "Bettors Love Skewness, Not Risk, at the Horse Track," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 205-225, February.