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Conditions Ensuring the Separability of Asset Demand for All Risk-Averse Investors

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  • Kaïs Dachraoui
  • Georges Dionne

Abstract

We explore how the demand for a risky asset can be separated into an investment effect and a hedging effect by all risk-averse investors. This question has been shown to be complex when considered outside of the mean-variance framework. We restrict dependence among returns on the risky assets to regression dependence and find that the demand for one risky asset can be decomposed into an investment component based on the risk premium offered by the asset and a hedging component used against fluctuations in the return on the other risky asset. We also show that the class of regression dependent distributions is larger than that of two-fund separating distributions. This conclusion opens up the search for broader distributional hypotheses suitable to asset-pricing models. Examples are discussed.

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Bibliographic Info

Paper provided by CIRPEE in its series Cahiers de recherche with number 0411.

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Date of creation: 2004
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Handle: RePEc:lvl:lacicr:0411

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Keywords: Portfolio choice; investment effect; hedging effect; regression dependence; two-fund separation; asset-pricing model; copulas;

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References

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  1. Davidson, Russell & Duclos, Jean-Yves, 1998. "Statistical Inference for Stochastic Dominance and for the Measurement of Poverty and Inequality," Cahiers de recherche 9805, Université Laval - Département d'économique.
  2. BEAULIEU, Marie-Claude & DUFOUR, Jean-Marie & KHALAF, Lynda., 2002. "Testing Mean-Variance Efficiency in CAPM with Possibly Non-Gaussian Errors : An Exact Simulation-Based Approach," Cahiers de recherche 2002-17, Universite de Montreal, Departement de sciences economiques.
  3. Elton, Edwin J. & Gruber, Martin J., 2000. "The Rationality of Asset Allocation Recommendations," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(01), pages 27-41, March.
  4. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  5. DENUIT, Michel & SAILLET, Olivier, 2001. "Nonparametric Tests for Positive Quadrant Dependence," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2001009, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES), revised 01 Apr 2001.
  6. Ross, Stephen A., 1978. "Mutual fund separation in financial theory--The separating distributions," Journal of Economic Theory, Elsevier, vol. 17(2), pages 254-286, April.
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Cited by:
  1. BEAULIEU, Marie-Claude & DUFOUR, Jean-Marie & KHALAF, Lynda, 2005. "Exact Multivariate Tests of Asset Pricing Models with Stable Asymmetric Distributions," Cahiers de recherche 2005-04, Universite de Montreal, Departement de sciences economiques.
  2. Georges Dionne & Jingyuan Li, 2012. "Comparative Ross Risk Aversion in the Presence of Quadrant Dependent Risks," Cahiers de recherche 1226, CIRPEE.

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