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On Abel's concept of doubt and pessimism

  • Jouini, E.
  • Napp, C.

In this paper, we characterize subjective probability beliefs leading to a higher equilibrium market price of risk. We establish that Abel's result on the impact of doubt on the risk premium is not correct in general; see Abel [2002. An exploration of the effects of pessimism and doubt on asset returns. Journal of Economic Dynamics and Control 26, 1075-1092]. We introduce, on the set of subjective probability beliefs, market-price-of-risk dominance concepts and we relate them to well-known dominance concepts used for comparative statics in portfolio choice analysis. In particular, the necessary first-order conditions on subjective probability beliefs in order to increase the market price of risk for all nondecreasing utility functions appear as equivalent to the monotone likelihood ratio property.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 32 (2008)
Issue (Month): 11 (November)
Pages: 3682-3694

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Handle: RePEc:eee:dyncon:v:32:y:2008:i:11:p:3682-3694
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. Giordani, Paolo & Söderlind, Paul, 2002. "Is there Evidence of Pessimism and Doubt in Subjective Distributions? A Comment on Abel," SSE/EFI Working Paper Series in Economics and Finance 519, Stockholm School of Economics, revised 15 Aug 2003.
  2. Ormiston Michael B. & Schlee Edward E., 1993. "Comparative Statics under Uncertainty for a Class of Economic Agents," Journal of Economic Theory, Elsevier, vol. 61(2), pages 412-422, December.
  3. Hadar, Josef & Seo, Tae Kun, 1990. "The Effects of Shifts in a Return Distribution on Optimal Portfolios," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(3), pages 721-36, August.
  4. Andrew B. Abel, 2001. "An Exploration of the Effects of Pessimism and Doubt on Asset Returns," NBER Working Papers 8132, National Bureau of Economic Research, Inc.
  5. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  6. Peter C. Fishburn & R. Burr Porter, 1976. "Optimal Portfolios with One Safe and One Risky Asset: Effects of Changes in Rate of Return and Risk," Management Science, INFORMS, vol. 22(10), pages 1064-1073, June.
  7. Stephen G. Cecchetti & Pok-sang Lam & Nelson C. Mark, 1998. "Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good To Be True?," NBER Working Papers 6354, National Bureau of Economic Research, Inc.
  8. Landsberger, Michael & Meilijson, Isaac, 1990. "Demand for risky financial assets: A portfolio analysis," Journal of Economic Theory, Elsevier, vol. 50(1), pages 204-213, February.
  9. Gollier Christian, 1995. "The Comparative Statics of Changes in Risk Revisited," Journal of Economic Theory, Elsevier, vol. 66(2), pages 522-535, August.
  10. Meyer, Jack & Ormiston, Michael B., 1983. "The comparative statics of cumulative distribution function changes for the class of risk averse agents," Journal of Economic Theory, Elsevier, vol. 31(1), pages 153-169, October.
  11. Gollier, Christian & Schlesinger, Harris, 2002. "Changes in risk and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(4), pages 747-760, May.
  12. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  13. Gollier, Christian, 1997. "A Note on Portfolio Dominance," Review of Economic Studies, Wiley Blackwell, vol. 64(1), pages 147-50, January.
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