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Incomplete Diversification and Asset Pricing

Author

Listed:
  • Dilip B. Madan
  • Frank Milne
  • Robert Elliott

Abstract

Investors in equilibrium are modeled as facing investor specific risk exposures arising from incomplete diversification of personal risks across the space of assets. Personalized asset pricing models reflect these risks. Averaging across the pool of investors we obtain a market asset pricing model that reflects market risk exposures. It is observed on invoking a law of large number applied to an infinite population of investors that many personally relevant risk considerations can be eliminated from the market asset pricing model. Examples illustrating the effects of undiversified labour income and taste specific price indices are provided. Suggestions for future work on asset pricing include a need to focus on identifying and explaining investor specific risk exposures.

Suggested Citation

  • Dilip B. Madan & Frank Milne & Robert Elliott, 1992. "Incomplete Diversification and Asset Pricing," Working Paper 865, Economics Department, Queen's University.
    • Handle: RePEc:qed:wpaper:865
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    References listed on IDEAS

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    1. Connor, Gregory, 1984. "A unified beta pricing theory," Journal of Economic Theory, Elsevier, vol. 34(1), pages 13-31, October.
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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