Downside risk neutral probabilities

Chaigneau, Pierre and Eeckhoudt, Louis (2016) Downside risk neutral probabilities. Financial Markets Group Discussion Papers (756). Financial Markets Group, The London School of Economics and Political Science, London, UK.

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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.

Item Type:	Monograph (Discussion Paper)
Official URL:	https://www.fmg.ac.uk/
Additional Information:	© 2016 The Authors
Divisions:	Financial Markets Group
Subjects:	H Social Sciences > HC Economic History and Conditions H Social Sciences > HG Finance
JEL classification:	D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
Date Deposited:	02 Jun 2023 23:03
Last Modified:	14 Sep 2024 04:29
URI:	http://eprints.lse.ac.uk/id/eprint/118980

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