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Option bounds and second order arbitrage opportunities

Research output: Working paper

Published
Publication date2004
Place of PublicationLancaster University
PublisherThe Department of Accounting and Finance
Number of pages60
Original languageEnglish

Publication series

NameAccounting and Finance Working Paper Series

Abstract

In this paper we investigate the relationship between risk aversion and cautiousness, two important risk preference measures. We show how high cautiousness is associated with low risk aversion and how bounds and limits of cautiousness imply bounds and limits of relative risk aversion respectively. We also show how the monotonicity of cautiousness implies the monotonicity of risk aversion. Interestingly, we find that decreasing cautiousness implies standard risk aversion. We also reveal a close relationship between cautiousness and relative risk tolerance. These results help us better understand various conditions concerning risk aversion and cautiousness. They may also shed light on how investors' investment decisions in the equity and options markets are related.