 Dynamic safety first expected utility modelMei Choi Chiu, Hoi Ying Wong and Jing Zhao European Journal of Operational Research, 2018, vol. 271, issue 1, 141-154 Abstract: Levy and Levy (2009) empirically show that a combination of safety first and expected utility (SFEU) principles play a key role in human decision-making process. This paper extends the SFEU model to the optimal dynamic investment in a continuous-time economy. We derive the analytic optimal trading strategy using the martingale approach. Interestingly, the optimal trading strategy replicates a portfolio of a vanilla call, a vanilla put, a digital put option, and a cash reserve. These derivatives therefore match the objective of SFEU investors, which offers an explanation to their popularity in the market. The model also implies that investors with more awareness of crash risk demand put options with lower strike price. Using option data of US major market indices and alternative proxies for market awareness of crash risk, we empirically test the model implications and find that market awareness of crash risk can explain the dynamics of index option open interest. Keywords: Finance; Safety first; Expected utility; Martingale approach; Crash risk (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:271:y:2018:i:1:p:141-154 DOI: 10.1016/j.ejor.2018.05.002 Access Statistics for this article European Journal of Operational Research is currently edited by Roman Slowinski, Jesus Artalejo, Jean-Charles. Billaut, Robert Dyson and Lorenzo Peccati More articles in European Journal of Operational Research from Elsevier |
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