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Cautiousness, Skewness Preference, and the Demand for Options

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  • James Huang
  • Richard Stapleton

Abstract

In this article we establish cautiousness as a new downside risk aversion measure, using a portfolio problem with a risk-free bond, a stock, and an option. We show that, an investor has higher cautiousness (i) if and only if she is always more likely to buy the option; and (ii) if and only if she always demands more options per share. As an option’s payoff is a convex function, increasing positions in the option increases the convexity of a portfolio, which leads to an increase in skewness. Thus the results in this article establish the link between cautiousness and skewness preference.

Suggested Citation

  • James Huang & Richard Stapleton, 2014. "Cautiousness, Skewness Preference, and the Demand for Options," Review of Finance, European Finance Association, vol. 18(6), pages 2375-2395.
    • Handle: RePEc:oup:revfin:v:18:y:2014:i:6:p:2375-2395.
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    File URL: http://hdl.handle.net/10.1093/rof/rft048
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    Cited by:

    1. Deniz Erdemlioglu & Nikola Gradojevic, 2021. "Heterogeneous investment horizons, risk regimes, and realized jumps," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(1), pages 617-643, January.
    2. Chaigneau, Pierre & Eeckhoudt, Louis, 2016. "Downside risk neutral probabilities," LSE Research Online Documents on Economics 118980, London School of Economics and Political Science, LSE Library.
    3. Richard Peter, 2021. "Who should exert more effort? Risk aversion, downside risk aversion and optimal prevention," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 71(4), pages 1259-1281, June.
    4. James Huang & Richard Stapleton, 2017. "Higher-order risk vulnerability," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 63(2), pages 387-406, February.

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