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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. Pierre Chaigneau & Louis Eeckhoudt, 2020. "Downside risk-neutral probabilities," Economic Theory Bulletin, Springer;Society for the Advancement of Economic Theory (SAET), vol. 8(1), pages 65-77, April.
    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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