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Downside Risk Neutral Probabilities

Pierre Chaigneau and Louis Eeckhoudt

Cahiers de recherche from CIRPEE

Abstract: The price of any asset can be expressed with risk neutral probabilities, which are adjusted to incorporate risk preferences. This paper introduces the concepts of downside (respectively outer) risk neutral probabilities, which are adjusted to incorporate the preferences for downside (resp. outer) risk and higher degree risks. We derive new asset pricing formulas that rely on these probability measures. Downside risk neutral probabilities allow to value assets in a simple mean-variance framework. The associated pricing kernel is linear in wealth, as in the CAPM. With outer risk neutral probabilities, the pricing kernel is quadratic in wealth, and can be U-shaped.

Keywords: Asset pricing; downside risk; quadratic pricing kernel; linear pricing kernel; prudence; risk neutral probabilities. (search for similar items in EconPapers)
JEL-codes: D81 G12 (search for similar items in EconPapers)
Date: 2015
New Economics Papers: this item is included in nep-rmg
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Journal Article: Downside risk-neutral probabilities (2020) Downloads
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