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Cautiousness and tendency to buy options

Research output: Working paper



As is well known, Arrow-Pratt measure of risk aversion explains investors’ behavior in stock markets while Kimball’s measure of prudence explains investors’ behavior when they make precautionary savings. What is missing is a measure of investors’ tendency to buy options. In this paper we show that cautiousness, which is equivalent to the ratio of prudence to risk aversion, is the measure. We also discuss some properties of this measure.