Risk neutral preferences

Résumé

In economics and finance, risk neutral preferences are preferences that are neither risk averse nor risk seeking. A risk neutral party's decisions are not affected by the degree of uncertainty in a set of outcomes, so a risk neutral party is indifferent between choices with equal expected payoffs even if one choice is riskier. Theory of the firm In the context of the theory of the firm, a risk neutral firm facing risk about the market price of its product, and caring only about profit, would maximize the expected value of its profit (with respect to its choices of labor input usage, output produced, etc.). But a risk averse firm in the same environment would typically take a more cautious approach. Portfolio theory In portfolio choice, a risk neutral investor who is able to choose any combination of an array of risky assets (various companies' stocks, various companies' bonds, etc.) would invest exclusively in the asset with the highest expected yield, ignoring i

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https://en.wikipedia.org/wiki/Risk_neutral_preferences

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The objective of this course is to provide a detailed coverage of the standard models for the valuation and hedging of derivatives products such as European options, American options, forward contracts, futures contract and exotic options.

This course provides students with a working knowledge of macroeconomic models that explicitly incorporate financial markets. The goal is to develop a broad and analytical framework for analyzing the interaction of financial decisions, macroeconomic events and policy decisions.

Participants of this course will master computational techniques frequently used in mathematical finance applications. Emphasis will be put on the implementation and practical aspects.

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Default And Systemic Risk In Equilibrium

Martin Larsson

We develop a finite horizon continuous time market model, where risk-averse investors maximize utility from terminal wealth by dynamically investing in a risk-free money market account, a stock, and a defaultable bond, whose prices are determined via equilibrium. We analyze the endogenous interaction arising between the stock and the defaultable bond via the interplay between equilibrium behavior of investors, risk preferences and cyclicality properties of the default intensity. We find that the equilibrium price of the stock experiences a jump at default, despite that the default event has no causal impact on the underlying economic fundamentals. We characterize the direction of the jump in terms of a relation between investor preferences and the cyclicality properties of the default intensity. We conduct a similar analysis for the market price of risk and for the investor wealth process, and determine how heterogeneity of preferences affects the exposure to default carried by different investors.

Wiley-Blackwell2015

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In the standard real options approach to investment under uncertainty, agents formulate optimal policies under the assumptions of risk neutrality or perfect capital markets. However, in most situations, corporate executives face incomplete markets either because they receive compensation packages that restrict their portfolios or because cash flows from the firm’s investment opportunities are not spanned by those of existing assets. The present paper examines the impact of managerial risk aversion on investment decisions when the manager is exposed to idiosyncratic risk and faces the risk of a control challenge. In the paper, the investment policy selected by the manager reflects a trade-off between his incentives to reduce risk and the need to ensure sufficient efficiency to prevent control challenges. The analysis demonstrates that risk aversion induces the manager to speed up investment, leading to a significant erosion of the value of the option to wait.

2007

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Real options and risk aversion

Julien Hugonnier, Erwan Morellec

In the standard real options approach to investment under uncertainty, agents formulate optimal policies under the assumptions of risk neutrality or complete financial markets. Although these assumptions are crucial to the implications of the approach, they are not particularly relevant to most real world environments where agents face incomplete markets and are exposed to undiversifiable risks. In this chapter we extend the real options approach to incorporate risk aversion for a general class of utility functions. We show that risk aversion provides an incentive for the investor to delay investment and leads to a significant erosion in project values.

2012

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