Downside risk-neutral probabilities

Pierre Chaigneau and Louis Eeckhoudt
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Louis Eeckhoudt: IÉSEG School of Management

Economic Theory Bulletin, 2020, vol. 8, issue 1, No 5, 65-77

Abstract: Abstract We show that there exists a probability measure under which the CAPM formula for expected returns holds for general utility functions and probability distributions. This probability measure, the “downside risk-neutral” measure, is adjusted to incorporate the effects of downside risk and higher degree risks. It thus belongs to the same family as the risk-neutral measure, which is also a risk-adjusted measure. Using risk preference theory, we interpret this change in probability measure in terms of risk substitution.

Keywords: Downside risk; Prudence; Risk aversion; Risk-neutral probabilities; Risk substitution (search for similar items in EconPapers)
JEL-codes: D81 G12 (search for similar items in EconPapers)
Date: 2020
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Working Paper: Downside risk neutral probabilities (2016)
Working Paper: Downside Risk Neutral Probabilities (2015)
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DOI: 10.1007/s40505-019-00165-5

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