Downside risk neutral probabilities

Pierre Chaigneau and Louis Eeckhoudt

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Risk neutral probabilities are adjusted to take into account the asset price effect of risk preferences. This paper introduces downside (respectively outer) risk neutral probabilities, which are adjusted to take into account the asset price effect of preferences for downside (resp. outer) risk and higher degree risks. Using risk preference theory, we interpret these three changes in probability measures in terms of risk substitution. With downside risk neutral probabilities, the pricing kernel is linear in wealth. Outer risk neutral probabilities can be viewed as a reasonable approximation of physical probabilities.

Keywords: downside risk; pricing kernel; prudence; risk aversion; risk neutral probabilities; risk substitution (search for similar items in EconPapers)
JEL-codes: D81 G12 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2016-04-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://eprints.lse.ac.uk/118980/ Open access version. (application/pdf)

Related works:
Journal Article: Downside risk-neutral probabilities (2020)
Working Paper: Downside Risk Neutral Probabilities (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:118980

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