Options Can Induce Risk Taking for Arbitrary Preferences

Posted: 23 Apr 2008

See all articles by Luis H.B. Braido

Luis H.B. Braido

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finan├žas

Daniel Ferreira

London School of Economics - Department of Finance; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Date Written: 2006

Abstract

It is widely believed that call options induce risk-taking behavior. However, Ross (2003) challenges this intuition by demonstrating the impossibility of inducing managers with arbitrary preferences to always act as if less risk averse. If preferences and price distributions are unknown, risk-taking behavior cannot be induced by options. Here, we prove a new result showing that, with absolutely no information about preferences and some knowledge about prices, one can write a call option that makes all managers prefer riskier projects to safer ones. This points out that in order to design options that induce risk taking it is sufficient to have information about price distributions.

Keywords: Stochastic Dominance, Stock Options, Risk Taking

JEL Classification: D81, G00, J33, M21

Suggested Citation

Braido, Luis Henrique Bertolino and Ferreira, Daniel, Options Can Induce Risk Taking for Arbitrary Preferences (2006). Economic Theory, Vol. 27, No. 3, 2006. Available at SSRN: https://ssrn.com/abstract=978662 or http://dx.doi.org/10.2139/ssrn.442280

Luis Henrique Bertolino Braido

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finan├žas ( email )

Praia de Botafogo 190, s.1100
Rio de Janeiro RJ 22253-900
Brazil
+55 21 2559 5868 (Phone)
+55 21 2553 8821 (Fax)

HOME PAGE: http://www.fgv.br/professor/lbraido/

Daniel Ferreira (Contact Author)

London School of Economics - Department of Finance ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
(+44) 20 7955 7544 (Phone)

HOME PAGE: http://personal.lse.ac.uk/FERREIRD/

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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