On Abel's concept of doubt and pessimism
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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"An exploration of the effects of pessimism and doubt on asset returns,"
Journal of Economic Dynamics and Control,
Elsevier, vol. 26(7-8), pages 1075-1092, July.
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Levine's Working Paper Archive
1401, David K. Levine.
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