Preference for Skewness in Investing: Chasing Big Wins

Why Investors Chase Skewness

Many investors are drawn to opportunities with a small chance of a very large payoff: lotteries, venture startups, out-of-the-money options, meme stocks, and other “lottery-like” assets. In behavioral finance, this is called preference for skewness—a tendency to favor return distributions with rare upside, even when the odds are poor.(1)(2)(3)

The appeal is intuitive. A positively skewed asset usually produces many small losses or modest gains, but occasionally delivers a huge winner.(1) That structure feels exciting because the upside is easy to imagine, while the low-probability losses are easier to dismiss. Research and industry commentary consistently note that investors often overvalue these long-shot payoffs and underweight their low expected returns.(4)(2)(5)

Why Big Wins Feel So Attractive

Behavioral finance helps explain why skewness is emotionally powerful. People do not evaluate outcomes only by average return; they also care about the shape of the payoff distribution.(2)(3) A small chance of wealth-changing upside can create outsized appeal because it offers hope, novelty, and the possibility of regret avoidance: no one wants to be the person who missed the next big winner.(4)(5)

This behavior is especially visible in retail investing. Skewed assets such as “lottery stocks” often have low or negative average returns, yet they remain popular because investors are willing to pay for the dream of a rare windfall.(4) As one explanation puts it, such assets have “many small losses and few large gains,” which makes them feel different from ordinary investments.(1)

The Market Cost of Chasing Skewness

That preference is not free. If many investors overpay for assets with extreme upside, those assets can become overpriced relative to their fundamentals.(4)(2) The result is that lottery-like stocks may underperform over the long run even though they attract strong demand.(4)(2)

There is also a deeper trade-off: investors generally dislike negative skewness, where an asset delivers frequent small gains but occasional catastrophic losses.(1)(5) Because those crash risks are psychologically painful, investors may demand compensation for holding them. That creates a skewness risk premium, meaning assets with worse skewness can sometimes offer higher expected returns as compensation for tail risk.(4)(2)

Where This Shows Up in Real Investing

Preference for skewness appears in several places:

Lotteries: Tiny odds of huge jackpots make the payoff distribution highly skewed, which is why lotteries are the clearest example of skew-chasing behavior.(4)(3)
Startups and venture capital: A few companies may generate extraordinary returns while most fail, so investors are often attracted by the possibility of one breakout winner.(2)(5)
Options and speculative stocks: These can provide asymmetric payoffs that appeal to investors seeking a home-run outcome rather than steady gains.(1)(5)

In practice, this means investors are often not just buying expected return; they are buying a story about extreme upside.(2)(5) That story can be rational in a diversified portfolio, but it can also become a behavioral trap when the odds are misunderstood or ignored.(4)(3)

How to Think About It Wisely

A healthy approach is to distinguish between aspiration and allocation. It is reasonable to want exposure to innovation and asymmetric upside, but concentrated bets on skewed assets can be costly if the expected return is poor or the downside is underestimated.(4)(5) The key question is not just, “Could this win big?” but also, “What is the probability-weighted outcome, and how much am I paying for that chance?”(1)(2)

FAQ

1. What is preference for skewness? It is the tendency to prefer investments with rare but very large upside, even if the average return is low or negative.(1)(2)(3)

2. Why do investors like lottery-like assets? Because the chance of a huge gain is emotionally compelling, and people often overweight small probabilities of large rewards.(4)(2)(5)

3. Is skewness always bad for investors? No. Positive skew can be useful for diversification or tactical strategies, but paying too much for it can reduce long-run returns.(4)(1)(5)

Sources

(1) Positive Skew in Trend Following - CAIS Group
(2) Skewness preferences, asset prices and investor sentiment (Applied Economics, RePEc record)
(3) Skewness expectations and portfolio choice (Experimental Economics, Cambridge Core)
(4) Good news: Skew, for lack of a better word is good (Substack, Klement on Investing)
(5) Skewness - Man Group