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Conditions Ensuring the Decomposition of Asset Demand for All Risk-Averse Investors

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  • Kais Dachraoui
  • Georges Dionne

Abstract

The paper explores how the demand for a risky asset can be decomposed into an investment effect and a hedging effect by all risk-averse investors. This question has been shown to be complex when considered outside of the mean-variance framework. Dependence among returns on the risky assets is restricted to quadrant dependence and it is found that the demand for one risky asset can be decomposed into an investment component based on the risk premium offered by the asset and a hedging component used against the fluctuations in the return on the other risky asset. The paper also discusses how the class of quadrant-dependent distributions is related to that of two-fund separating distributions. This contribution opens up the search for broader distributional hypotheses suitable to asset demand models. Examples are discussed.

Suggested Citation

  • Kais Dachraoui & Georges Dionne, 2007. "Conditions Ensuring the Decomposition of Asset Demand for All Risk-Averse Investors," The European Journal of Finance, Taylor & Francis Journals, vol. 13(5), pages 397-404.
    • Handle: RePEc:taf:eurjfi:v:13:y:2007:i:5:p:397-404
    DOI: 10.1080/13518470601025326
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    1. Stephen A. Ross, 2005. "Mutual Fund Separation in Financial Theory—The Separating Distributions," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 10, pages 309-356, World Scientific Publishing Co. Pte. Ltd..
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    3. Owen, Joel & Rabinovitch, Ramon, 1983. "On the Class of Elliptical Distributions and Their Applications to the Theory of Portfolio Choice," Journal of Finance, American Finance Association, vol. 38(3), pages 745-752, June.
    4. Zhou, Guofu, 1993. "Asset-Pricing Tests under Alternative Distributions," Journal of Finance, American Finance Association, vol. 48(5), pages 1927-1942, December.
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    6. Chamberlain, Gary, 1983. "A characterization of the distributions that imply mean--Variance utility functions," Journal of Economic Theory, Elsevier, vol. 29(1), pages 185-201, February.
    7. Cass, David & Stiglitz, Joseph E., 1970. "The structure of investor preferences and asset returns, and separability in portfolio allocation: A contribution to the pure theory of mutual funds," Journal of Economic Theory, Elsevier, vol. 2(2), pages 122-160, June.
    8. Michel Denuit, 2004. "Nonparametric Tests for Positive Quadrant Dependence," Journal of Financial Econometrics, Oxford University Press, vol. 2(3), pages 422-450.
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    Cited by:

    1. Jingyuan Li & Georges Dionne, 2010. "A Theoretical Extension of the Consumption-based CAPM Model," Cahiers de recherche 1047, CIRPEE.
    2. Georges Dionne & Jingyuan Li & Cedric Okou, 2012. "An Extension of the Consumption-based CAPM Model," Cahiers de recherche 1214, CIRPEE.
    3. Dionne, Georges & Li, Jingyuan, 2014. "When can expected utility handle first-order risk aversion?," Journal of Economic Theory, Elsevier, vol. 154(C), pages 403-422.
    4. Georges Dionne & Jingyuan Li, 2012. "Comparative Ross Risk Aversion in the Presence of Quadrant Dependent Risks," Cahiers de recherche 1226, CIRPEE.
    5. Georges Dionne & Jingyuan Li & Cédric Okou, 2024. "An alternative representation of the C-CAPM with higher-order risks," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 49(2), pages 194-233, September.
    6. Jingyuan Li, 2012. "Precautionary saving in the presence of labor income and interest rate risks," Journal of Economics, Springer, vol. 106(3), pages 251-266, July.

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    More about this item

    Keywords

    Portfolio choice; investment effect; hedging effect; quadrant dependence; two-fund separation; Asset demand model;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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