Downside risk neutral probabilities
Chaigneau, P. & Eeckhoudt, L.
(2016).
Downside risk neutral probabilities.
(Financial Markets Group Discussion Papers 756).
Financial Markets Group, The London School of Economics and Political Science.
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 | Working paper |
|---|---|
| Copyright holders | © 2016 The Authors |
| Departments | LSE > Research Centres > Financial Markets Group |
| Date Deposited | 02 Jun 2023 |
| URI | https://researchonline.lse.ac.uk/id/eprint/118980 |