Heterogeneity of Investors and Asset Pricing on a Risk-Value World

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 which generalize the Markowitz-model. We use a behaviorally based risk measure with an endogenous or exogenous benchmark. A richer set of sharing rules is obtained than in an expected utility world. If the risk measure is modelled by a negative HARA-function, then sharing rules are convex or concave relative to each other. The pricing kernel convexity increases with heterogeneity of investors making claims contingent on states of high and low aggregate payo more expensive. An increase in heterogeneity raises investors' needs for trading options and also makes all European options more expensive relative to the price of the underlying asset.

Keywords: Decision Making Under Risk, Asset Pricing, Convexity of Pricing Kernel, Heterogeneity of Investors

JEL Classification: D81, G11, G12, G13