Stochastic dominance and behavior towards risk: The market for Internet stocks |
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Authors: | Wai Mun Fong Hooi Hooi Lean Wing Keung Wong |
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Institution: | aDepartment of Finance, NUS Business School, National University of Singapore, Singapore 117592, Singapore;bEconomics Program, School of Social Sciences, Universiti Sains Malaysia, 11800 USM, Penang, Malaysia;cDepartment of Economics, Hong Kong Baptist University, Kowloon Tong, Hong Kong |
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Abstract: | Internet stocks registered large gains in the late 1990s, followed by large losses from early 2000. Using stochastic dominance theory, we infer how investor risk preferences have changed over this cycle, and relate our findings to utility theory and behavioral finance. Our major findings are as follows. First, risk averters and risk seekers show a distinct difference in preference for Internet versus “old economy” stocks. This difference is most evident during the bull market period (1998–2000) where Internet stocks stochastically dominate old economy stocks for risk seekers but not risk averters. In the bear market, risk averters show an increased preference for old economy stocks, while risk seekers show a reduced preference for Internet stocks. These results are inconsistent with prospect theory and indicate that investors exhibit reverse S-shaped utility functions. |
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Keywords: | Stochastic dominance Prospect theory Utility functions Gambles |
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