A note on wealth effect under CARA utility

Dmitry Makarov () and Astrid V. Schornick

Finance Research Letters, 2010, vol. 7, issue 3, 170-177

Abstract: There is a simple but overlooked way of capturing the wealth effect under CARA utility via making the absolute-risk aversion parameter wealth-dependent. We implement this approach in the asymmetric information setting of Verrecchia (1982), and compare it with the alternative approach of changing the utility function (Peress, 2004). Ours is a straightforward tractable extension of Verrecchia, while Peress has to resort to approximate methods. Importantly, our closed-form solution reveals that the relation between wealth and wealth share invested in a risky asset can be negative, while Peress's main result is that this relation is uniquely positive.

Keywords: CARA; utility; Wealth; effect; Information; acquisition; Asset; pricing; Portfolio; choice (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:7:y:2010:i:3:p:170-177

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