Other Assets' Risk: Asset-Prices and Perceptions of Asset-Risk

Due to wealth effects, the price of a security may vary with the realization of an underlying risk factor even when the security's dividend is independent of that factor. This paper highlights a crucial component of these effects hitherto ignored by the literature: changes in wealth do not alter only an agent's risk aversion, but also her perceived "riskiness" of the security. The latter enhances significantly the extent to which market-clearing leads to endogenously-generated correlation across asset prices and returns, over and above that induced by correlation between payoffs, giving the appearance of "contagion".