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Comparative Statics of Asset Prices: the effect of other assets' risk

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  • Theodoros M. Diasakos

    ()

    (University of St. Andrews)

Currently, financial economics is unable to predict changes in asset prices with respect to changes in the underlying risk factors, even when an asset's dividend is independent of a given factor. This paper takes steps towards addressing this issue by highlighting a crucial component of wealth effects on asset prices hitherto ignored by the literature. Changes in wealth do not only alter an agent's risk aversion, but also her perceived ``riskiness'' of a security. The latter enhances significantly the extent to which market-clearing leads to endogenously-generated correlation across asset prices, over and above that induced by correlation between payoffs, giving the appearance of ``contagion.''

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Paper provided by Department of Economics, University of St. Andrews in its series Discussion Paper Series, Department of Economics with number 201315.

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Date of revision: 08 Jan 2014
Handle: RePEc:san:wpecon:1315
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