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Rationalizing Investors Choice

Listed author(s):
  • Carole Bernard
  • Jit Seng Chen
  • Steven Vanduffel

Assuming that agents' preferences satisfy first-order stochastic dominance, we show how the Expected Utility paradigm can rationalize all optimal investment choices: the optimal investment strategy in any behavioral law-invariant (state-independent) setting corresponds to the optimum for an expected utility maximizer with an explicitly derived concave non-decreasing utility function. This result enables us to infer the utility and risk aversion of agents from their investment choice in a non-parametric way. We relate the property of decreasing absolute risk aversion (DARA) to distributional properties of the terminal wealth and of the financial market. Specifically, we show that DARA is equivalent to a demand for a terminal wealth that has more spread than the opposite of the log pricing kernel at the investment horizon.

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File URL: http://arxiv.org/pdf/1302.4679
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Paper provided by arXiv.org in its series Papers with number 1302.4679.

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Date of creation: Feb 2013
Date of revision: Jan 2014
Handle: RePEc:arx:papers:1302.4679
Contact details of provider: Web page: http://arxiv.org/

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