Discussion Paper Details

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Title: Heterogeneity of Investors and Asset Pricing in a Risk-Value World

Author(s): GŁnter Franke and Martin Weber

Publication Date: March 2003

Keyword(s): asset pricing, convexity of pricing kernal, decision-making under risk and heterogeneity of investors

Programme Area(s): Financial Economics

Abstract: Portfolio choice and the implied asset pricing are usually derived assuming maximization of expected utility. In this Paper, they are derived from risk-value models that generalize the Markowitz-model. We use a behaviourally based risk measure with an endogenous or exogenous benchmark. If the risk measure is modelled by a negative HARA-function, then sharing rules are convex or concave relative to each other. A measure of heterogeneity of investors is derived. More heterogeneity (a) raises convexity/concavity of sharing rules and, thus, the need of investors to trade options, (b) increases convexity of the pricing kernel, (c) raises option prices relative to the price of the under-lying asset and (d) raises the variance and kurtosis of the risk-neutral probability distribution of the aggregate pay-off.

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Bibliographic Reference

Franke, G and Weber, M. 2003. 'Heterogeneity of Investors and Asset Pricing in a Risk-Value World'. London, Centre for Economic Policy Research.