We consider the demand for state contingent claims in the presence of a zero-mean, nonhedgeable background risk. An agent is defined to be generalized risk averse if he/she reacts to an increase in background risk by choosing a demand function for contingent claims with a smaller slope. We show...

We consider the demand for state contingent claims in the presence of a zero-mean, nonhedgeable background risk. An agent is defined to be generalized risk averse if he/she reacts to an increase in background risk by choosing a demand function for contingent claims with a smaller slope. We show...

Contrary to well-known asset pricing models, volatilities implied by equity index options exceed realized stock market volatility and exhibit a pattern known as the volatility skew. We explain both facts using a model that can also account for the mean and volatility of equity returns. Our model...

Contrary to the Black-Scholes model, volatilities implied by index option prices depend on the exercise price of the option and are often higher than realized volatilities. We explain both facts in the context of a model that can also explain the mean and volatility of equity returns. Our model...

In this paper, we combine modern portfolio theory and option pricing theory so that a trader who takes a position in a European option contract and the underlying assets can construct an optimal portfolio such that at the moment of the contract's maturity the contract is perfectly hedged. We...

Weather derivatives (WD) are different from most financial derivatives because the underlying weather cannot be traded and therefore cannot be replicated by other financial instruments. The market price of risk (MPR) is an important parameter of the associated equivalent martingale measures used...