Options can induce risk taking for arbitrary preferences

Luis H. B. Braido () and Daniel Ferreira

Economic Theory, 2006, vol. 27, issue 3, pages 513-522

Abstract: It is widely believed that call options induce risk-taking behavior. However, Ross (2004) challenges this intuition by demonstrating the impossibility of inducing managers with arbitrary preferences to always act as if they were less risk averse. If preferences and price distributions are unknown, risk-taking behavior cannot be always induced by an option contract. Here, we prove a new result showing that, with no information about preferences and some knowledge about prices, one can write a call option that makes all managers prefer riskier projects to safer ones. This points out that in order to design options that induce risk taking it is sufficient to have information about price distributions. Copyright Springer-Verlag Berlin/Heidelberg 2006

Keywords: Stochastic dominance; Stock options; Risk taking. (search for similar items in EconPapers)
Date: 2006

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